Attached files
file | filename |
---|---|
EX-31.2 - QKL Stores Inc. | v179200_ex31-2.htm |
EX-32.1 - QKL Stores Inc. | v179200_ex32-1.htm |
EX-10.31 - EX-10.31 - QKL Stores Inc. | v179200_ex1031.htm |
EX-31.1 - QKL Stores Inc. | v179200_ex31-1.htm |
EX-4.5 - EX-4.5 - QKL Stores Inc. | v179200_ex10-29.htm |
EX-10.29 - EX-10.29 - QKL Stores Inc. | v179200_ex10-31.htm |
EX-4.6 - EX-4.6 - QKL Stores Inc. | v179200_ex10-30.htm |
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark
One)
þ
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
|
For
the fiscal year ended December 31, 2009
Or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
|
For
the transition period from ________ to __________
Commission
file number 033-10893
QKL
STORES INC.
(Exact
Name of Registrant as Specified in Its Charter)
Delaware
|
75-2180652
|
|
(State or Other Jurisdiction
of Incorporation or Organization)
|
(I.R.S. Employer
Identification No.)
|
Jingqi
Street
44
Dongfeng Xincun
Sartu
District
163311
Daqing, P.R. China
(Address
of Principal Executive Offices) (Zip Code)
Registrant’s
telephone number, including area code: (011) 86-459-460-7626
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
|
Name of each exchange on which registered
|
|
Common Stock, par value $0.001 per share
|
NASDAQ Capital Market
|
Securities
registered pursuant to Section 12(g) of the
Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No
þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act. Yes o No
þ
Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past
90 days. Yes þ No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer o
|
Smaller
reporting company þ
|
Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2). Yes o No
þ
The
aggregate market value of the registrant’s common stock, $0.001 par value
per share, held by non-affiliates of the registrant on June 30, 2009, was
approximately $7,560,227 (based on the closing sales price of the registrant’s
common stock on that date ($4.20). Shares of the registrant’s common stock
held by each officer and director and each person known to the registrant to own
10% or more of the outstanding voting power of the registrant have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not a determination for other purposes.
APPLICABLE
ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE
YEARS:
Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Section 12, 13 or 15 of the Securities Exchange Act of
1934 subsequent to the distribution of securities under a plan confirmed by a
court.
Yes o No o
(APPLICABLE
ONLY TO CORPORATE REGISTRANTS)
Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date. As of March 29, 2010 there
were 29,653,431 shares of common stock outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE: None
QKL
STORES, INC.
ANNUAL
REPORT ON FORM 10-K
FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2009
TABLE OF
CONTENTS
PART
I
|
||||
ITEM
1
|
BUSINESS
|
1
|
||
ITEM
1A
|
RISK
RACTORS
|
22
|
||
ITEM
1B
|
UNRESOLVED
STAFF COMMENTS
|
35
|
||
ITEM
2
|
PROPERTIES
|
35
|
||
ITEM
3
|
LEGAL
PROCEEDINGS
|
39
|
||
ITEM
4
|
(REMOVED
AND RESERVED)
|
39
|
||
PART
II
|
|
|||
ITEM
5
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
40
|
||
ITEM
6
|
SELECTED
FINANCIAL DATA
|
41
|
||
ITEM
7
|
MAMANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
41
|
||
ITEM
7A
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
41
|
||
ITEM
8
|
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
|
42
|
||
ITEM
9
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
|
42
|
||
ITEM
9A
|
CONTROLS
AND PROCEDURES
|
42
|
||
ITEM
9B
|
OTHER
INFORMATION
|
43
|
||
PART
III
|
|
|||
ITEM
10
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|
44
|
||
ITEM
11
|
EXECUTIVE
COMPENSATION
|
44
|
||
ITEM
12
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
44
|
||
ITEM
13
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
44
|
||
ITEM
14
|
PRINCIPAL
ACCOUNTANTING FEES AND SERVICES
|
44
|
||
PART
IV
|
||||
ITEM
15
|
|
EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
|
|
45
|
i
CAUTIONARY
STATEMENT
This
annual report contains forward-looking statements. Forward-looking statements
give our current expectations or forecasts of future events. You can identify
these statements by the fact that they do not relate strictly to historical or
current facts. Forward-looking statements involve risks and uncertainties.
Forward-looking statements include statements regarding, among other things, (a)
our projected sales, profitability and cash flows, (b) our growth strategies,
(c) anticipated trends in our industries, (d) our future financing plans and (e)
our anticipated needs for working capital. They are generally identifiable by
use of the words “may,” “will,” “should,” “anticipate,” “estimate,” “plan,”
“potential,” “projects,” “continuing,” “ongoing,” “expects,” “management
believes,” “we believe,” “we intend” or the negative of these words or other
variations on these words or comparable terminology. In particular, these
include statements relating to future actions, future performance, sales
efforts, expenses, the outcome of contingencies such as legal proceedings, and
financial results.
Any or
all of our forward-looking statements in this annual report may turn out to be
inaccurate. They can be affected by inaccurate assumptions we might make or by
known or unknown risks or uncertainties. Consequently, no forward-looking
statement can be guaranteed. Actual future results may vary materially as a
result of various factors, including, without limitation, the risks outlined
under “Risk Factors” and matters described in this annual report generally. In
light of these risks and uncertainties, there can be no assurance that the
forward-looking statements contained in this filing will in fact occur and you
should not place undue reliance on these forward-looking
statements.
PART
I
Item
1.
|
Business
|
References
to “QKL-China” are to Daqing Qing Ke Long Chain Commerce & Trade Co., Ltd.,
a People’s Republic of China retail company that we control through a series of
contractural arrangements described in the section entitled “Our History and
Corporate Structure.” Unless otherwise specified or required by context,
references to “we,” “our,” “us” and the “Company” refer collectively to (i) QKL
Stores Inc. (formerly known as Forme Capital, Inc.), (ii) the subsidiaries of
QKL Stores Inc., which are Speedy Brilliant Group Limited, a British Virgin
Islands company (“Speedy Brilliant (BVI)”), which is wholly owned by QKL Stores
Inc., and Speedy Brilliant Commercial Consultancy Co., Ltd. (“Speedy Brilliant
(Daqing)”), which is wholly owned by Speedy Brilliant (BVI), (iii) QKL-China,
and (iv) Daqing Qinglongxin Commerce & Trade Co., Ltd. (“QC&T”), a
wholly owned subsidiary of QKL-China. For convenience, certain amounts in
Chinese Renminbi (“RMB”) have been converted to United States dollars at an
exchange rate of $1 = RMB 6.8282, the exchange rate on December 31, 2009.
References to “IGA” are to the Independent Grocers Alliance, an international
trade group and network of supermarkets that offers its members access to
industry information, bargaining advantages with suppliers, and other benefits
of affiliation with a large trade group. IGA reports that its member companies
operate in 40 countries worldwide and have total revenues of $21 billion per
year. Its website is www.IGA.com . References in this annual report to the “PRC”
or “China” are to the People’s Republic of China.
In
keeping with standard practice and the practice of the National Bureau of
Statistics of China, references to “northeastern China” are to the three
northeastern provinces of Heilongjiang, Jilin and Liaoning. A map showing these
provinces is included in the section of this report entitled “Other
References.”
References
to QKL-China’s “registered capital” are to the equity of QKL-China, which under
PRC law is measured not in terms of shares owned but in terms of the amount of
capital that has been or will be contributed to a company by a particular
shareholder or all shareholders. The portion of a limited liability company’s
total capital contributed by a particular shareholder represents that
shareholder’s ownership of the company and the total amount of capital
contributed by all shareholders is the company’s total equity. Capital
contributions are made to a company by deposits into a dedicated account in the
company’s name, which the company may access in order to meet its financial
needs. When a company’s accountant certifies to PRC authorities that a capital
contribution has been made and the company has received the necessary government
permission to increase its contributed capital, the capital contribution is
registered with regulatory authorities and becomes a part of the company’s
“registered capital.”
1
Summary
We are a
regional supermarket chain that currently operates 34 supermarkets and two
department stores in northeastern China and Inner Mongolia. Our supermarkets
sell a broad selection of merchandise including groceries, fresh food and
non-food items. We have distribution center servicing our
supermarkets.
We are
the 1st supermarket
chain in northeastern China and Inner Mongolia that is a licensee of the
Independent Grocers Alliance, or IGA, a United States-based global grocery
network with aggregate retail sales of more than $21.0 billion per year. As a
licensee of IGA, we are able to engage in group bargaining with suppliers and
have access to more than 2,000 private IGA brands, including many that are
exclusive IGA brands.
Our total
revenues for the year ended December 31, 2009 was approximately $247.6 million,
an increase of $87.5 million, or 54.7%, compared to total revenues of $160.1
million for the year ended December 31, 2008. Our net income excluding changes
in fair value of warrants for the year ended December 31, 2009 was
approximately $10.8 million, an increase of $1.8 million, or 20.0%, from
approximately $9.0 million for the year ended December 31, 2008.
Our
Industry
We
operate in the supermarket industry in China, which is a part of the country’s
retail trade sector. We believe the retail market has benefited from compelling
industry fundamentals such as rapid economic growth, urbanization and increasing
disposable income.
China’s
economy has been experiencing consistent growth with nominal GDP growing from
approximately $1.9 trillion in 2004 to approximately $4.9 trillion in 2009. As a
result of China’s rapid economic growth, the urban population has increased
dramatically as people in rural and less developed areas migrate to cities in
search of better jobs and higher living standards. During the period between
2004 and 2009, the total urban population in China increased by approximately
79.0 million, or approximately 14.6%. This growth has been accompanied by rising
income levels of urban households where annual per capita disposable income
increased from $1,379 in 2004 to $2514 in 2009 a compound growth rate of 12.8%.
A growing middle class combined with an increasing affluence and purchasing
power has driven the rapid development of the retail sector and in turn driven a
large increase in consumer spending. Consumer spending has grown from $789
billion in 2004 to approximately $1.8 trillion in 2009, a compound growth rate
of approximately 18.4%.
Northeast
China has a population of 133 million, or approximately 9% of China’s
population. In December 2007, a major economic-development plan for northeastern
China, the “Plan for Revitalizing Northeast China,” was announced by an office
of the PRC’s State Counsel. We believe that the plan indicates a commitment by
the PRC government to make economic development of northeastern China a high
priority. We also believe that this development is likely to contribute to our
growth.
Company
History
On March
28, 2008, QKL Stores Inc. (formerly known as Forme Capital, Inc.) acquired
control of QKL-China through a “reverse merger” transaction. Upon completion of
the reverse merger transaction, QKL Stores Inc. ceased to be a shell company (as
that term is defined in Rule 12b-2 under the Securities Exchange Act of 1934
(the “Exchange Act”)).
Private
Placement Transaction
At the
same time as the closing of the reverse merger transaction, we closed a private
placement of securities, in which we sold 9,117,647 units to certain accredited
investors, for gross proceeds to us of $15.5 million, at a purchase price of
$1.70 per unit. Each unit consists of one share of Series A Preferred Stock
(each of which is convertible into one share of our common stock), one Series A
Warrant and one Series B Warrant (each of which is exercisable to purchase 0.625
of a share of common stock or, in the aggregate, are exercisable to purchase up
to a total of 11,397,058 shares of our common stock). The Series A Warrants have
an exercise price of $3.40 per share (subject to adjustment) and the Series B
Warrants have an exercise price of $4.25 per share (subject to adjustment). We
received $13.5 million as net proceeds from this private placement. The closing
of the private placement was conditioned on the closing of the reverse merger
transaction.
2
For more
information about the private placement you should read the section of this
report entitled “Our History and Corporate Structure.”
Public
Offering
In
November 2009 we raised an aggregate of $39.7 million in a public offering of
6,900,00 shares of our common stock at a price of $5.75 per share.
Name
Change
On June
18, 2008, we changed our name from Forme Capital, Inc. to QKL Stores Inc. On the
same date, our name change reflected on the Over-the-Counter Bulletin Board
(“OTCBB”) and our common stock began trading under the stock symbol QKLS.OB. On
October 21, 2009, our common stock was listed on NASDAQ under the symbol
“QKLS.”
Executive
Office
Our
executive offices are located at 44 Jingqi Street, Dongfeng Xincun, Sartu
District, Daqing, 163311 P.R.C. and our telephone number is (011)
86-459-4607626. Our corporate website is www.qklstoresinc.com .
Information contained on, or accessed through our website is not intended to
constitute and shall not be deemed to constitute part of this
report.
Overview
We are a
regional supermarket chain that currently operates 34 supermarkets and 2
department stores in the northeastern three provinces and Inner Mongolia. Our
supermarkets sell a broad selection of merchandise including groceries, fresh
food and non-food items. We currently have one distribution center servicing our
supermarkets.
We are
the first supermarket chains in northeastern China and Inner Mongolia that is a
licensee of the Independent Grocers Alliance, or IGA, a United States-based
global grocery network with aggregate retail sales of more than $21.0 billion
per year. As a licensee of IGA, we are able to engage in group bargaining with
suppliers and have access to more than 2,000 private IGA brands, including many
that are exclusive IGA brands.
Our
expansion strategy emphasizes growth through geographic expansion in
northeastern China and Inner Mongolia, where we believe local populations can
support profitable supermarket operations, and where we believe competition from
large foreign and national supermarket chains, which generally have resources
far greater than ours, is limited. Our strategies for profitable operations
include buy-side initiatives to reduce supply costs; focusing on merchandise
with higher margins, such as non-food items, foods we prepare ourselves and
private label merchandise; and increasing reliance on the benefits of membership
in the international trade group IGA.
We
completed the initial steps in the execution of our expansion plan in March
2008, when we raised financing through the combination of our reverse merger and
private placement. Under our expansion plan, we opened seven new stores in 2009
that have, in the aggregate, approximately 32,000 square meters of space and ten
new stores in 2008 that have, in the aggregate, approximately 42,000 square
meters of space. Six of the stores opened in 2008 were opened by us and four of
the stores were opened through the acquisition of existing businesses by us. In
2010, we plan to open hypermarkets and additional supermarkets department stores
having, in the aggregate, approximately 100,000 square meters of space and one
additional distribution center in the second quarter of 2010 that will have
approximately 19,600 square meters of space. We are also making improvements to
our logistics and information systems to support our supermarkets. We expect to
finance our expansion plan from funds generated from operations, bank loans and
proceeds from our fourth quarter 2009 public offering, and our long-term target
is to open 200 stores over the next five years, including hypermarkets,
supermarkets and department stores.
Our
Competitive Advantages
We
believe that our competitive advantages include our low prices, the quality of
our meat and produce, our breadth of products, and the location of our
stores.
3
The
location of our stores is also essential to our competitiveness, and our current
competition strategy focuses on locating our stores within the three provinces
of northeastern China and the eastern region of Inner Mongolia. Within those
areas, we try to locate our stores in small- and medium-sized cities/counties
where we expect to face limited competition from large foreign or national
supermarket chains.
In
addition to the competitive advantages described above, we believe we have
specific and distinct advantages over our domestic and foreign
competitors.
Compared
with local supermarkets, we believe we have the following
advantages:
|
§
|
Strong
relationships with local suppliers;
|
|
§
|
Membership
in the international trade group IGA, which provides access to purchasing
discounts for packaged goods and access to IGA’s exclusive
brands;
|
|
§
|
Superior
management, especially in inventory management, information management
systems, and sales and marketing
programs;
|
|
§
|
A
focus on human-resource management, including formal employee training
programs; and
|
|
§
|
A
management team with global experiences in the supermarket
industry.
|
Compared
with large foreign supermarkets, we believe we have the following
advantages:
|
§
|
A
familiarity with Chinese and local circumstances and culture, religion and
customs, and a corresponding understanding of local customer needs and
consumption patterns, which we believe are especially helpful in the areas
of raw food and meat sales;
|
|
§
|
Our
supermarkets are positioned within their respective markets as stores that
provide goods and services at low prices in a manner that is convenient to
our communities. By contrast, we believe that Wal-Mart and other foreign
retailers are perceived in Daqing and other medium-sized cities in
northeastern China as places for higher priced and more extravagant
purchases;
|
|
§
|
Strong
relationships with local suppliers;
and
|
|
§
|
Certain
advantages under Chinese law, such as the right to sell cigarettes, a
right foreign competitors do not
enjoy.
|
Business
Strategy
Our
strategy is to expand our current market share and to benefit from the
anticipated growth in China’s retail industry. Our operating strategy consists
of the following key elements:
|
§
|
Emphasizing
growth through geographic expansion in the three northeastern provinces
and Inner Mongolia where there is an emerging market for our retail
operations and where competition is
limited.
|
|
§
|
Reducing
cost of goods sold by (i) acquiring more merchandise directly from
manufacturers, cutting out middlemen and distributors, and otherwise
reducing supply costs, and (ii) building a larger distribution center to
enable us to purchase larger orders from vendors at lower prices, and
(iii) taking advantage of the purchasing power of collective ordering of
supplies through IGA.
|
|
§
|
Increasing
our profit margins by (i) offering and selling more self-prepared foods,
which have higher profit margins, including baked goods made in our
bakery, and cooked meats such as fried chicken legs and roast
chicken, (ii) offering and selling more private label goods,
which also have higher profit margins, and (iii) increasing non-food
section in newly opened stores to increase gross
margin.
|
4
In 2009
and 2008, we acquired approximately 12% and 10.0%, respectively, of our
merchandise directly from manufacturers (not including private label
merchandise). We estimate that approximately 6% of our total revenue in 2009 was
due to sales of self-prepared foods compared to approximately 5.5% of our total
revenue in 2008.
Our
strategy is to increase our sales of these cost-saving and higher-margin
categories of merchandise — direct-from-manufacturer, self-prepared food,
private label and IGA-related merchandises. In addition to emphasizing sales of
these categories, we also emphasize sales of other higher-margin items, such as
fashionable clothing and cosmetics, and seasonal items like gloves, coats,
sun-block and swimsuits, etc.
Our
Stores and Merchandise
Our
stores are spread throughout northeastern China and Inner Mongolia with a
concentration in Heilongjiang Province. The map below shows the location within
Heilongjiang province of all of our current locations. The right side of the map
depicts Heilongjiang Province; the left side depicts our stores and its
surrounding areas. The retail locations are indicated by a “QKL” mark; our
distribution center is indicated by a red truck icon.
Map
of locations — Heilongjiang Province and Municipality of Daqing
Our
Supermarkets
Our
supermarkets generated approximately 98.8% of our revenues in 2009 and 98.6% of
our revenue in 2008. Our current supermarkets have a total area of approximately
133,410 gross square meters, which includes all rental space as opposed to
85,688 square meters of retail space. All supermarkets share the same general
format and sell from the same inventory, however the larger stores carry a
greater variety of items than the smaller stores.
Our
supermarkets are designed to provide our customers with quality merchandise at a
low price and carry a broad selection of grocery, meat, produce, liquor and
tobacco, clothing, household items, small electronics, jewelry and general
merchandise.
5
Our
supermarkets carry merchandise divided into three major categories: grocery,
fresh food, and non-food items.
The table
below sets forth our total revenues for our sales of grocery, fresh food and
non-food items for the years ended December 31, 2007, 2008 and 2009
Percentage of Store sales for the Year
Ended December 31,
|
||||||||
2008
|
2009
|
|||||||
Grocery
|
32.3 | % | 33.6 | % | ||||
Fresh
food
|
50.5 | % | 47.5 | % | ||||
Non-food
items
|
17.2 | % | 18.9 | % |
Grocery items
include:
|
§
|
Prepared
or packaged foods, including instant foods, canned foods, packaged rice
and wheat powder, and crackers and
chips;
|
|
§
|
Bulk
(unpackaged) grains including rice and ground
wheat;
|
|
§
|
Bottled
water and beverages;
|
|
§
|
Cigarettes;
and
|
|
§
|
Certain
non-food items such as cleaning products, cosmetics, and disposable
razors.
|
Fresh-food items
include:
|
§
|
Fresh
raw meat, which we cut and package;
|
|
§
|
Cooked
meats;
|
|
§
|
Fresh
seafood;
|
|
§
|
Fresh
bakery items, including breads, buns, dumplings, and other self-prepared
foods;
|
|
§
|
Fresh
noodles and pastas;
|
|
§
|
Fresh
milk, yogurt, and eggs (supplied fresh every day);
and
|
|
§
|
Packaged
dumplings (supplied fresh every
day).
|
Non-food items include all
non-food items, except cleaning and cosmetic items included in grocery;
specifically:
|
§
|
Clothing
and shoes;
|
|
§
|
Books
and stationery;
|
|
§
|
Bedding
and home furnishings;
|
|
§
|
Small
electronics and household use items like irons, electric shavers, hair
dryers, massage machines; and
|
|
§
|
Office
supplies, toys, sporting goods and other
items.
|
6
Our
target rate for loss due to spoilage and breakage of perishable and breakable
items is 0.4% of total revenue. This was also our approximate rate of loss for
spoilage and breakage in both 2008 and 2009.
Private
Label
Some of
the merchandise we sell in our supermarkets is made to our specifications by
manufacturers, using our QKL brand name. We refer to such merchandise as
“private label” merchandise. With private label merchandise, we entrust the
manufacturer to make the product and to select the name and design. Under our
agreements with the private label manufacturers, the private label manufacturers
cannot sell the product to any other company. Average profit margins from
private label products are typically 20%-30%, with certain products having a
profit margin of 30-50%, and are generally higher than profit margins for other
grocery items which are typically 12-13%.
Sales of
private label merchandise represented approximately 5.5 % and 5.0% of our total
sales revenue for 2009 and 2008, respectively. In June 2008, we established a
specialized department for designing and purchasing private label merchandise.
Six full-time employees currently work in this department. We plan to increase
the proportion of private label merchandise sold over the next several quarters.
Our goal is to increase private label sales to 20% of our total revenues in the
near future.
Our
Department Stores
As of the
date of this report, we operate two department stores through QKL-China’s
subsidiary, Daqing Qinglongxin Commerce & Trade Co., Ltd. (“QC&T”). Our
department stores generated 0.95% and 1.2% of our total revenues in 2009 and
2008, respectively. Our department stores are located in the same buildings as
our supermarkets and are licensed to sell all of the non-food products sold by
our supermarkets. Our department stores sell brand-name and luxury clothing and
accessories, cosmetics, small electronics, jewelry, books, home furnishings, and
bedding, and contain a movie theater and a traditional beauty
salon.
Our first
department store opened in September 2006 and is located in Ranghulu District of
Daqing. It has a total area of 12,000 square meters, including approximately
3,000 square meters occupied by our supermarket on the ground floor of the
building.
On
September 28, 2008, we opened a new supermarket store and a department store in
Taikang, a county in Heilongjiang Province located approximately 30 kilometers
from Daqing. It is the Company’s second unit comprised of a supermarket and
department store. It occupies roughly 10,000 square meters of leased space (the
supermarket is approximately 2,800 square meters and the department store is
nearly 7,200 square feet) in the commercial center of the city.
Our
department store business model is different from our supermarket business
model. The department stores operate on a concession and rent basis, with the
selling space occupied by retail partners who either sublet their space from, or
pay concession fees for use of the space to, QC&T. We do not own the
merchandise sold in the department stores, yet we do receive the proceeds of the
sales of merchandise in the department stores. The merchandise is owned by our
retail partners, we render the revenue we collected to them by deducting our
percentage of fees. In 2009 and 2008, approximately 67.9% and 66.2%,
respectively, of our department store revenue came from concession fees and
approximately 32.1% and 33.8%, respectively, came from rent.
Our
department store business model also differs from our supermarket business
model, in that our retail partners conduct their own purchasing operations (in
consultation with QC&T employees) and do not use our purchasing department.
Our retail partners receive their merchandise by delivery from distributors and
do not use our distribution center, delivery vehicles or logistics resources.
Each of the three above-ground floors in each of the department stores (but not
the ground floor, which houses a QKL-China supermarket) is occupied by a number
of stores, each operated by a retail partner. Each floor has one floor manager
who is employed by QC&T and who oversees the workings of that floor. The
employees charged with the logistical operation of the stores are employees of
our retail partners. Compared to our supermarket operations, our department
store operations are simpler and are less demanding of our resources, including
time, labor and purchasing effort.
Our
Distribution Centers
We
currently distribute grocery products to our supermarkets from our two
distribution centers located in Daqing, one for fresh food and one for grocery
and non-food merchandise. Approximately 45.0% of the merchandise sold in our
supermarkets are distributed through these facilities, which are located 1.5
kilometers and 5 kilometers from our headquarters. We plan to open a new
distribution center in the second quarter of 2010 located in Harbin, a city in
Heilongjiang Province, which will have approximately 19,600 square meters of
space and is approximately 180 kilometers from our headquarters in
Daqing.
7
Size
of Our Supermarkets
The table
below sets forth the size of our stores in net square meters, which includes
retail space as opposed to all rental space, and the average monthly sales per
square meter of each of our supermarkets during 2008 and 2009.
Store
Number
|
Store Name
|
Date Opened
|
Retail Space
Square
Meters
|
Average Monthly
Sales (In RMB)
per Square Meter,
2008
|
Average
Monthly Sales
(In RMB) per
Square Meter,
2009
|
|||||||||||
1
|
Xincun
Store
|
01/23/99
|
4,408 | 1,371 | 2,369 | |||||||||||
2
|
Longfeng
Store
|
06/18/00
|
1,499 | 2,920 | 3,222 | |||||||||||
3
|
Chengfeng
Store
|
05/12/01
|
2,706 | 1,644 | 1,523 | |||||||||||
4
|
Hengmao
Store
|
11/16/02
|
1,906 | 3,141 | 3,556 | |||||||||||
5
|
Yixi
Store
|
01/18/03
|
1,557 | 2,796 | 2,988 | |||||||||||
6
|
Wanbao
Store
|
04/26/03
|
1,290 | 1,453 | 1,764 | |||||||||||
7
|
Xizhai
Store (1)
|
06/28/03
|
3,118 | 2,295 | 2,065 | |||||||||||
8
|
Zhaoyuan
Store
|
03/29/08
|
2,246 | 479 | 1,723 | |||||||||||
9
|
Zhaodong
Store
|
12/07/03
|
1,669 | 3,151 | 2,995 | |||||||||||
10
|
Wanli
Store
|
04/18/04
|
1,541 | 1,468 | 1,884 | |||||||||||
11
|
Hubin
Store
|
12/25/04
|
1,163 | 1,049 | 1,931 | |||||||||||
12
|
Donghu
Store
|
09/24/05
|
2,315 | 1,855 | 2,589 | |||||||||||
13
|
Yichun
Store
|
01/23/06
|
3,160 | 1,522 | 1,345 | |||||||||||
14
|
Jixi
Store
|
09/17/06
|
2,500 | 1,939 | 1,954 | |||||||||||
15
|
Acheng
Store
|
05/20/06
|
4,035 | 2,436 | 1,887 | |||||||||||
16
|
Lusejiayuan
Store
|
04/30/06
|
760 | 1,108 | 2,341 | |||||||||||
17
|
Jixi
Store 2
|
03/29/07
|
1,720 | 1,955 | 1,639 | |||||||||||
18
|
Yixi
Store 2
|
09/09/06
|
866 | 664 | 2,180 | |||||||||||
19
|
Harbin
Store
|
12/27/06
|
2,370 | 1,245 | 1,719 | |||||||||||
20
|
Central
Street Store
|
09/27/08
|
4,968 | 2,781 | 2,222 | |||||||||||
21
|
Suihua
Store
|
07/12/08
|
1,883 | 1,223 | 2,392 | |||||||||||
22
|
Taikang
Store
|
09/14/08
|
1,560 | 3,313 | 2,501 | |||||||||||
23
|
Zhaodong
Dashijie
|
05/27/09
|
2,587 | — | 2,599 | |||||||||||
24
|
Lindian
|
04/01/09
|
2,196 | — | 2,358 | |||||||||||
25
|
Boli
Store
|
12/21/08
|
4,045 | 433 | 1,107 | |||||||||||
26
|
Xinguangtiandi
Store
|
04/28/09
|
2,066 | — | 1,921 | |||||||||||
27
|
Hailaer
Store
|
12/28/08
|
4,606 | 3,113 | 1,377 | |||||||||||
28
|
Anda
Store
|
11/22/08
|
1,595 | 2,962 | 2,877 | |||||||||||
29
|
Fuyu
Store
|
11/29/08
|
1,630 | 3,303 | 2,227 | |||||||||||
30
|
Nehe
Store
|
11/11/08
|
1,774 | 2,801 | 2,308 | |||||||||||
31
|
Shidai
Lijing Store
|
06/21/03
|
101 | 616 | 701 | |||||||||||
33
|
Zhalaiteqi
Store
|
12/13/09
|
1,727 | — | 2,766 | |||||||||||
34
|
Tongjiang
Store
|
9/30/09
|
2,115 | — | 1,958 | |||||||||||
35
|
Datong
Store
|
11/07/09
|
2,590 | — | 1,820 | |||||||||||
36
|
Nongan
Store
|
12/20/09
|
4,987 | — | 2,715 | |||||||||||
Average
|
2,240 | 1,835 | 2,158 |
(1)
|
This
store has been temporarily closed for refurbishment and will re-open in
the 4 th
quarter of 2010.
|
8
Recent
Developments
Supermarket
Store Openings
Tongjiang
Store
On
September 30, 2009, we opened one new supermarket in Tongjiang, a border city
next to Russia in Heilongjiang province, approximately 800 kilometers from
Daqing. The new store occupies approximately 4,000 square meters in a large
shopping center in the commercial area in Tongjiang. More than 40,000 people in
the rural area plus additional people from surrounding suburban areas may shop
in our new store. The store carries more than 13,000 products in fresh food,
groceries and nonfood items. Since the store only open for one day during the
third quarter, meaningful sales data is not available yet.
Lindian
Store
On April
1, 2009, we opened a new supermarket store in Lindian, a city in Heilongjiang
Province, approximately 140 kilometers from Daqing. The new store occupies
approximately 5,000 square meters in the commercial center of
Lindian.
The
county of Lindian has a population of approximately 80,000. Based on our own
independent research, we believe there are no other large supermarket stores in
Lindian.
Zhaodong
Dashijie Store
On May
27, 2009, we opened a new supermarket store in Zhaodong, a city in Heilongjiang
Province, approximately 115 kilometers from Daqing. The new store occupies
approximately 6,000 square meters in the commercial center of Zhaodong. It is
the second store the Company opened in Zhaodong city.
The city
of Zhaodong has a population of approximately 230,000.
Datong
Store
On
November 7, 2009 we opened a new supermarket store in Datong, Heilongjiang
Province. Datong District is rich in oil and natural gas and is
surrounded by farmlands with abundant agriculture. With no competing
stores in the area, the Company’s modern supermarket will address the population
of approximately 85,000 people. The Datong store occupies an area of
4,340 square meters and carries a wide variety of grocery, fresh food and
non-food products.
Zhalaiteqi
Store
On
December 13th, 2009
the company opened a new supermarket store in the city of Zhalaiteqi, Inner
Mongolia, which has a population of approximately 40,000. As the
first modern supermarket in Zhalaiteqi, the store occupies an area of 2,880
square meters and carries items across all three of the Company’s core
categories.
Nong’an
Store
On
December 20, 2009 we opened a new supermaret in Nong’an County, Jilin, a city
with a population of approximately one million residents. Nong’an
County is one of the largest counties in China in terms grain
production. The Nong’an store occupies an area of 7,485 square meters
and carries a wide variety of grocery, food and non-food items.
Acquisitions
of Existing Businesses
Xinguangtiandi
Store
On
September 30, 2008, we entered into an agreement with Daqing Xinguangtiandi
Shopping Center Co., Ltd. to acquire the business and all of the assets of a
supermarket store located in the Xinguangtiandi shopping center in Daqing. The
assets included the lease, the inventory and all licenses held. The
Xinguangtiandi store occupies approximately 3,700 square meters in a commercial
shopping center in Daqing. The purchase price of RMB 13.8 million (approximately
$2.0 million) was paid in two installments: a deposit of RMB 100,000
(approximately $14,590) was paid prior to October 15, 2008 and the remaining
balance was paid on December 2, 2008, the date of the completion of the transfer
of the seller’s assets and the relevant government registration procedures
regarding the change of the ownership.
9
We
reopened the Xinguangtiandi Store on April 30, 2009.
Renovations
Xizhai
Store
We
temporarily closed our Xizhai store in Daqing on June 1, 2009 due to a
renovation of the building by the landlord. After the renovation the size of the
store will be increased to 7,000 square meters. We anticipate that
the store will be reopened before the end of 2010.
Our
Equipment
The
equipment we use in operating our business includes standard equipment for our
industry, such as display cases, freezers and ovens, delivery trucks, and the
computer hardware and software used in our electronic information, inventory and
logistics system. All of our equipment is owned outright by us and was acquired
by cash purchase.
Advertising
and Publicity
We
advertise in many ways, including direct-marketing circulars (bi-weekly, weekly
and 3 days on weekends), local newspaper advertisements and coupons, membership
cards and member promotions, and general promotions such as discounts and prize
lotteries.
Our
marketing and advertising activities are conducted by our marketing department,
which has ten employees. The department’s responsibility covers a wide range of
issues, including our brand strategy and brand promotion, sales promotion,
design of advertising materials, design of décor of stores, and management of
our club membership. They are also engaged in market and price investigation. We
base our advertising on our analysis and observations of the market and our
competitors. The head of the marketing department works closely with the
purchasing department in determining purchasing and sales patterns.
Under
contracts we have with our suppliers, our suppliers are responsible for the
costs of most of the discounts and promotions
Customers
and Pricing
Our
pricing strategy is to offer merchandise of a quality comparable to that of our
competitors and at a competitive price.
In
general, all customers pay the same price for our merchandise. However, the
following discounts are available to some customers as part of our promotional
marketing strategy.
|
§
|
We
have a program where bulk buyers may receive discounts by negotiation,
which currently has over 650,000 members. These discounts are typically up
to 2.0% of our retail price, depending on what our annual gross margin
targets allow. Sales to these customers represented less than 2% of our
total revenues for 2009 and less than 2.0% of our total revenues for
2008.
|
|
§
|
Membership
card holders may receive discounts on select products during promotional
periods. Sales to these customers represented 36.8% of our
total revenues in 2009 and 25.9% of our total revenues for
2008.
|
The rest
of our customers, including large customers such as school cafeterias, pay our
standard price.
10
Payment
methods for customers include cash, bank cards, and two kinds of store cards:
cash cards, which can be charged in advance and used as cash, and membership
cards, which can deposit money in, accumulate points and provide discounts for
membership products.
In recent
years, the pricing of our merchandise has changed as the price of our supplies
has changed. For example, in 2007, the price of pork rose significantly and
store prices rose correspondingly, until they were partially offset by
government subsidies. The price of imported products, primarily including wine,
beer and liquor, has changed as the RMB exchange rate has changed. We do not
believe any price changes have had a significant effect on our business to
date.
Suppliers
Our 10
largest suppliers of merchandise in 2009 were, from largest to
smallest:
|
§
|
Fengyou
Wang (Vegetable Vendor);
|
|
§
|
Fan
Huang (Fruit Vendor);
|
|
§
|
Daqing
Huayao Economic and Trade Company;
|
|
§
|
Heilongjiang
Longjiangfu food and oil Ltd.;
|
|
§
|
Lianxiang
Li (Meat Vendor);
|
|
§
|
Daqing
Hongtaiyuan Economic and Trade
Ltd.;
|
|
§
|
Harbin
Pepsi Cola Co., Ltd.;
|
|
§
|
Daqing
Tianyi Food, Ltd.;
|
|
§
|
Heilongjiang
Cigarettes Company, Daqing Branch;
and
|
|
§
|
Harbin
Hongyang Economic and Trade, Ltd.
|
Customers
have the right under PRC law to return defective or spoiled products to us for a
full refund. Pursuant to the same law, our suppliers are required to fully
reimburse us for these returns.
Choosing
Suppliers
We
typically have two or more suppliers for each product we sell. Even for special
brands, including western beverages, we have several distributors from whom we
can order. We choose among competing suppliers on the basis of price and the
strategic needs of our business.
Shipping
from Suppliers
We
receive most of our merchandise from suppliers, which are often large
distribution companies, which deliver goods by their own trucks sent either to
our distribution center (in the case of grocery and non-food items) or directly
to our stores (in the case of fresh food items).
We
receive some merchandise direct from agricultural producers or manufacturers,
which arrive by train or truck and ships to a convenient location where we
transfer it to our delivery trucks. Our Daqing distribution centers also receive
train shipments directly through train tracks on the premises.
11
Distribution
to Our Supermarkets and Department Stores
For
distribution from our distribution centers to our supermarkets, we use our own
trucks to deliver merchandise in the Daqing area. We hire third-party
shipping companies to deliver goods to stores more distant from
Daqing. We follow a delivery schedule determined by our electronic
information, inventory and logistics system.
Distribution
to our department stores is arranged by our retail partners, as described under
“Our Department Stores” above.
Pricing
and Terms of Payment to Suppliers
We have
three kinds of payment arrangements with our suppliers: cash payment,
pre-payment and payment in arrears. The terms of these arrangements are
negotiated individually with each supplier and formalized in written
contracts.
Employees
As of
December 31, 2009, we had approximately 3,877 employees, all of whom are
full-time employees. Approximately 3,516 of our employees work in operations and
approximately 361 work in management. We have signed standard labor employment
contracts with all our employees, including our executive officers, with a
standard term of two to five years, and we have an employee manual that sets
forth relevant policies. We also hire temporary employees, typically for a term
of three months.
Under
each of our employment contracts, we are required to comply with applicable
labor laws and are obligated to:
|
§
|
Provide
a safe and sanitary working
environment;
|
|
§
|
Provide
regular breaks for employees;
|
|
§
|
Comply
with mandated limits on each employee’s weekly working
hours;
|
|
§
|
Obey
applicable minimum wage standards;
|
|
§
|
Provide
necessary training for technical or specialized
tasks;
|
|
§
|
Make
required payments to retirement, unemployment and medical insurance
plans;
|
|
§
|
Provide
30 days’ notice of termination to an employee, except in special
circumstances; and
|
|
§
|
Terminate
an employee’s employment only for certain reasons, specifically, if the
employee:
|
|
§
|
Proves
unsuitable for employment during a probation
period;
|
|
§
|
Seriously
neglects employment duties, causing harm to our
interests;
|
|
§
|
Forces
us to terminate or amend a labor contract against our will by means of
deception, coercion or taking advantage of difficulties experienced by
us;
|
|
§
|
Simultaneously
enters an employment relationship with another employer that seriously
affects the employee’s ability to complete the tasks of the Company, or
refuses to remedy the situation after we point out the
problem;
|
|
§
|
Seriously
violates our disciplinary policy;
or
|
|
§
|
Is
guilty of criminal acts and/or is subject to criminal
prosecution.
|
12
Employee
benefits include five state-mandated insurance plans:
|
§
|
Retirement
insurance: We withhold a portion of each employee’s
monthly salary, which is determined by the provincial government, and is
generally 8.0%, and contribute to a pooled fund an additional amount
determined by law, up to approximately 20.0% of the employee’s monthly
salary.
|
|
§
|
Medical
insurance: We withhold approximately 2.0% of each
employee’s salary and contribute to a pooled fund an additional amount
totaling approximately 8.0% of total payroll
expense.
|
|
§
|
Unemployment
insurance: We withhold approximately 1.0% of each
employee’s salary and contribute to a pooled fund an additional amount
totaling approximately 2.0% of total payroll
expense.
|
|
§
|
Worker’s comp.
insurance: We pay 5% of base amount salary of RMB 1,140
for each employee and contribute to a pooled fund. We don’t withhold
employees’ salary for it;
|
|
§
|
Maternity
insurance: We pay 0.7% of base amount of RMB 1,140 for
each employee and contribute to a pooled fund. We don’t withhold
employees’ salary for it.
|
In 2009
our average compensation per employee per month was RMB1,372 (approximately
$201) compared to RMB 1,084 (approximately $156) in 2008. We also pay benefits
in the form of social security insurance fees for each of our
employees.
We have a
system of human resource performance review and incentive policies that allow
personnel reviews to be carried out monthly, quarterly or annually.
Training
We have a
business school and training center at our headquarters in Daqing, which
includes a lecture hall where we provide professional advancement and management
courses, training in company policies and compliance with regulations, and
lectures by outside members of the business community.
There are
also monthly meetings with all the store managers, led by our CEO or COO. There
are regional training conferences once per week, which provide opportunities for
sharing experiences and improving our business performance, as well as for
developing the skills and judgment of our store managers.
Intellectual
Property
We have
registered the name “Qingkelong” as a trademark in the PRC, details of which are
set forth below:
Trademark
|
Certificate No.
|
Category
|
Owner
|
Valid Term
|
||||
Qingkelong
|
No.
1995020
|
No.
35: “sales promotion (for others)”
|
Qingkelong
|
4/7/03
–
4/6/13
|
Insurance
Vehicle
Insurance
We have a
standard commercial vehicle insurance policy in place for all of our delivery
trucks.
Comprehensive
(“All-Risk”) Property Insurance
A number
of comprehensive property insurance policies are held by us covering losses to
our retail stores and distribution center. Our “all-risk” policies range in
coverage amounts from RMB 270,000 (approximately $39,455) to RMB 51.6 million
(approximately $7.5 million) at related premiums that range between RMB 51,639
(approximately $7,546) to RMB 270 (approximately $39), respectively, for the
one-year periods they cover.
13
Public
Liability Insurance
Each of
our stores carries a public liability insurance policy, covering losses relating
to claims of loss or damage due to injuries occurring on our premises. Our
public liability policies typically have a coverage amount of RMB 2 million
(approximately $292,261) and a premium of RMB 3,000 (approximately $438), with
the exception of our Acheng store, which has a coverage amount of RMB 7.2
million (approximately $1.1 million) and a premium of RMB 7,212 (approximately
$1,054), for the one-year periods they cover.
Research
and Development Activities
We are
not presently engaged in any research and development activities. However, for
self-prepared products (e.g. baked goods), our fresh foods department and bakery
department perform continuing market investigations in order to determine how
other companies are making prepared foods and whether we can improve on those
methods. Our cooking personnel and head chef work with the purchasing department
to develop formulas for use in our stores.
Government
Regulation of Our Operations
Our
operations are subject to a wide range of regulations covering every aspect of
our business. The most significant of these regulations are set forth below. In
each case, we have passed the most recent required inspections and have received
appropriate and up-to-date licenses, certificates and authorizations, as set
forth in the next subsection of this annual report.
|
§
|
Circular
of State Administration of Industry and Commerce Concerning the Relevant
Issues for the Administration of Registration of Chain Stores in effect on
May 30, 1997, which sets forth the conditions for the establishment for
chain stores and branches, and the procedures for applying for a business
license.
|
|
§
|
Circular
Concerning the Relevant Issues on the Management of Specific Goods by
Chain Stores (collectively promulgated by PRC State Economic and Trade
Commission, Ministry of Domestic Trade, Ministry of Culture, Ministry of
Posts and Telecommunication, General Administration of Press and
Publication, State Administration for Industry and Commerce and State
Tobacco Monopoly Bureau) in effect on June 25, 1997, which provides that
chain stores must obtain a license from relevant government authorities
for the management of specific goods, such as tobacco, pharmaceutical
products, food products and audio-video
products..
|
|
§
|
Relevant
Opinions on the Promotion for the Development of Chain Stores, promulgated
by PRC State Commission for Economic Restructuring and State Economic and
Trade Commission, in effect on September 27, 2002, which provides relevant
opinions on the promotion for the development of chain stores, such as
simplifying the administrative approval
procedures.
|
Approvals,
Licenses and Certificates
We
require a number of approvals, licenses and certificates in order to operate our
business. We believe we are in compliance in all material respects with all laws
relevant to the operation of our business.
Competition
Competitive
Environment
The
supermarket industry in China is intensely competitive, with many companies,
both local and foreign, competing as retailers of food, groceries and other
merchandise, using a variety of business strategies.
Our main
competitors are local, regional and national chain supermarkets, and national
and foreign chain retailers operating “big box” or hypermarket stores of the
kind made famous by Wal-Mart and Carrefour.. We also face competition from
traditional street markets and markets where customers can purchase live poultry
and fish, convenience stores, tobacco and liquor retailers, restaurants,
specialty retailers and large drugstore chains.
14
We do not
believe we currently face significant direct competition from China’s large
national supermarket chains as we have decided not to compete in the areas in
which they focus their operations, which are China’s biggest cities and
surrounding suburbs-Shanghai, Shenzhen, Guangzhou, Beijing, and Chongqing-all
areas outside of northeastern China and Inner Mongolia. Instead, we have decided
to focus on China’s less-populated “second tier” and “third tier” cities and
surrounding areas in northeastern China and Inner Mongolia, which we believe
provide ample opportunity for expansion.
Among the
large foreign supermarket chains currently doing business in China, we believe
that Wal-Mart is currently the only significant direct competitor to one of our
stores. This is also primarily due to our choice of store locations. Although
Carrefour, Metro, Tesco and other foreign companies also operate in China and
compete with local supermarkets in their locations, they do not have a
significant number of stores in northeastern China or Inner Mongolia, where our
stores are located. In addition, our expansion plan targets small and
medium-sized cities and counties, which we believe are not being targeted by
these large international retailers. We believe that these plans will allow us
to avoid intense competition from these retailers.
Our
Competitors — Domestic Supermarkets
We
believe that the two supermarket companies listed below are our most significant
direct domestic competitors based in China:
|
§
|
Dashang Supermarkets is
a national supermarket/department store chain consisting of approximately
70 supermarkets/department stores located in 30 cities across China. Its
headquarters are located in Dalian City, Liaoning Province. The chain is
managed by Dashang Group Co., Ltd., one of China’s largest retailers,
which operates more than 60 medium- to large-sized retail outlets,
including department stores, shopping malls and specialty stores. We
believe that, as of the date of this annual report, approximately nine of
our stores compete directly with one Dashang supermarket/department store,
which is about 20 kilometers away from our headquarter in
Daqing.
|
|
§
|
Huachen Supermarkets is
a local supermarket chain consisting of approximately 10 supermarkets. Its
headquarters are located in Suihua City, Heilognijiang Province. Five of
its stores are in the same city or county as ours competing directly with
our stores.
|
Our
Competitors — Foreign Supermarkets
Wal-Mart is the world’s
largest retailer and has more than 200 stores and 70,000 employees in China. Of
its China stores, nearly 100 are in its supermarket or hypermarket format, three
are in its Sam’s Club format, two are in its neighborhood market format, and
approximately 100 are operated under the name of its partially-owned PRC
affiliate, Trust-Mart. We believe that approximately six of our stores compete
directly with one Wal-Mart store, which is about 200 meters from one of our
Xincun Store.
National
and foreign retailers have greater resources and a greater geographic range than
we do, and their stores are often bigger (hypermarkets often have an area of
14,000 square meters of retail space, compared to the average 2,240 square
meters of retail space of our stores), which may enable them to offer a greater
variety of products. This may give them advantages in terms of pricing, ability
to expand, advertising budgets, efficiencies in distribution, bargaining power,
and other areas.
OUR
HISTORY AND CORPORATE STRUCTURE
Organizational
History of QKL Stores Inc.
Prior to
June 18, 2008, QKL Stores Inc. was known as Forme Capital, Inc.
Forme
Capital, Inc. (“Forme”) was incorporated in Delaware on December 2, 1986. Prior
to 1989, Forme’s only activity was the creation and spinning off to its
stockholders of nine blind pool companies, or companies with no specified
business plan. From 1989 to 1998, Forme was a real estate company. From 1999 to
2000, Forme invested in fine art. From 2000 to 2007, Forme had no operations or
substantial assets. Accordingly, Forme was deemed to be a “blank check” or shell
company, that is, a development-stage company that has no significant non-cash
assets and either has no specific business plan or purpose or has indicated that
its business plan is to engage in a merger or other acquisition with an
unidentified company.
15
On
November 13, 2007, Forme filed an Amended and Restated Certificate of
Incorporation to change the number of shares of stock that it was authorized to
issue to 100,000,000 shares of common stock, par value $0.001 per share, and
100,000,000 shares of preferred stock, par value $0.01 per share. The change
became effective on December 5, 2007.
We have
no operations or substantial assets other than those of QKL-China, over which we
acquired control in the reverse merger transaction discussed below. Prior to the
reverse merger transaction, our business plan was to seek out and obtain
candidates with which we could merge or whose operations or assets could be
acquired through the issuance of common stock and possibly debt.
The
Reverse Merger Transaction
On March
28, 2008, we completed a number of related transactions through which we
acquired control of QKL-China: (i) a restructuring transaction which granted
control of QKL-China to another PRC entity, Speedy Brilliant (Daqing), and (ii)
a share exchange transaction, which transferred ownership and control of Speedy
Brilliant (Daqing) to us.
We refer
to the restructuring transaction and the share exchange transaction together as
the “reverse merger transaction.” The purpose of the reverse merger was to
acquire control of QKL-China. We did not acquire QKL-China directly by either
issuing stock or paying cash for QKL-China (or for Speedy Brilliant (Daqing))
because under PRC law it is uncertain whether a share exchange would be legal,
and the terms of a cash purchase would not have been favorable. Speedy Brilliant
(Daqing) did not acquire QKL-China directly, by either issuing its own stock or
paying cash for QKL-China, because under PRC law it is uncertain whether such a
share exchange would be legal, and the terms of a cash purchase would not have
been favorable to Speedy Brilliant (Daqing).
We
instead chose to acquire control of QKL-China through the contractual
arrangements described below because alternative methods of acquisition —
specifically, the acquisition of QKL — China outright either by share exchange
or by cash payment — was not available or advisable as described above.
Acquisition of QKL-China by share exchange was not available to Speedy Brilliant
(Daqing) because (i) Speedy Brilliant (Daqing) is wholly owned by Speedy
Brilliant (BVI), a British Virgin Islands company, and is therefore a wholly
foreign-owned entity under PRC law, (ii) wholly foreign-owned entities are,
under PRC law, treated as foreign entities for relevant regulatory purposes, and
(iii) under PRC laws that became effective on September 8, 2006, it is uncertain
both what procedures must be used in order for a foreign entity to acquire a PRC
entity by share exchange and whether such an acquisition would have binding
legal effect in the PRC. Acquisition of QKL-China for cash was not advisable for
Speedy Brilliant (Daqing) because the terms of such a cash acquisition,
including (i) a purchase price for QKL-China determined under PRC law and (ii)
the terms of a financing transaction in which we would raise the funds to pay
the purchase price, would not have been favorable to Speedy Brilliant
(Daqing).
PRC
Restructuring Agreements
The PRC
restructuring transaction was effected by the execution of five agreements
between Speedy Brilliant (Daqing), on the one hand, and QKL-China (and in some
cases the shareholders of QKL-China), on the other hand. Those five agreements
and their consequences are described below.
Consigned
Management Agreement
The
Consigned Management Agreement among Speedy Brilliant (Daqing), QKL-China and
all of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing)
will provide financial, business management and human resources management
services to QKL-China that will enable Speedy Brilliant (Daqing) to control
QKL-China’s operations, assets and cash flow, and in exchange, QKL-China will
pay a management fee to Speedy Brilliant (Daqing) equal to 4.5% of QKL-China’s
annual revenue. The management fee for each year is due by January 31 of the
following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
Technology
Service Agreement
The
Technology Service Agreement among Speedy Brilliant (Daqing), QKL-China and all
of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing) will
provide technology services, including the selection and maintenance of
QKL-China’s computer hardware and software systems and training of QKL-China
employees in the use of those systems, and in exchange QKL-China will pay a
technology service fee to Speedy Brilliant (Daqing) equal to 1.5% of QKL-China’s
annual revenue. The technology service fee for each year is due by January 31 of
the following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
16
Loan
Agreement
The Loan
Agreement among Speedy Brilliant (Daqing) and all of the shareholders of
QKL-China, provides that Speedy Brilliant (Daqing) will make a loan in the
aggregate principal amount of RMB 77 million (approximately $11.2 million) to
the shareholders of QKL-China, each shareholder receiving a share of the loan
proceeds proportional to its shareholding in QKL-China, and in exchange each
shareholder agreed (i) to contribute all of its proceeds from the loan to the
registered capital of QKL-China in order to increase the registered capital of
QKL-China, (ii) to cause QKL-China to complete the process of registering the
increase in its registered capital with PRC regulatory authorities within 30
days after receiving the loan, and (iii) to pledge their equity to Speedy
Brilliant (Daqing) under the Equity Pledge Agreement described
below.
The loan
is repayable by the shareholders at the option of Speedy Brilliant
(Daqing) either by the transfer of QKL-China’s equity to Speedy Brilliant
(Daqing) or through proceeds indirectly from the transfer of QKL-China assets to
Speedy Brilliant (Daqing). The loan does not bear interest, except that if (x)
Speedy Brilliant (Daqing) is able to purchase the equity or assets of QKL-China,
and (y) the lowest allowable purchase price for that equity or those assets
under PRC law is greater than the principal amount of the loan, then, insofar as
it is allowable under PRC law, interest will be deemed to have accrued on the
loan in an amount equal to the difference between the lowest allowable purchase
price for QKL-China and the principal amount of the loan. The effect of this
interest provision is that, if and when permitted under PRC law, Speedy
Brilliant (Daqing) may acquire all of the equity or assets of QKL-China by
forgiving the loan, without making any further payment. If the principal amount
of the loan is greater than the lowest allowable purchase price for the equity
or assets of QKL-China under PRC law, then Speedy Brilliant (Daqing) would
exempt the shareholders from paying the difference between the two amounts. The
effect of this provision is that (insofar as allowable under PRC law) the
shareholders of QKL-China may satisfy their repayment obligations under the loan
by transferring all of QKL-China’s equity or assets to Speedy Brilliant
(Daqing), without making any further payment.
The Loan
Agreement also contains promises from the shareholders of QKL-China that during
the term of the agreement they will elect as directors of QKL-China only
candidates nominated by Speedy Brilliant (Daqing), and they will use their best
efforts to ensure that QKL-China does not take certain actions without the prior
written consent of Speedy Brilliant (Daqing), including (i) supplementing or
amending the articles of association or rules of QKL-China, or of any subsidiary
controlled or wholly owned by it, (ii) increasing or decreasing its registered
capital or shareholding structure, (iii) transferring, mortgaging or disposing
of any interests in its assets or income, or encumbering its assets or income in
a way that would affect Speedy Brilliant (Daqing)’s security interest unless
required for QKL-China’s normal business operations, (iv) incurring or
succeeding to any debts and liabilities, (v) entering into any material contract
(exceeding RMB 5.0 million, or approximately $0.7 million, in value); (vi)
providing any loan or guarantee to any third party; (vii) acquiring or
consolidating with any third party, or investing in any third party; and (viii)
distributing any dividends to the shareholders in any manner. In addition, the
Loan Agreement provides that at Speedy Brilliant (Daqing)’s request, QKL-China
will promptly distribute all distributable dividends to its
shareholders.
The funds
that Speedy Brilliant (Daqing) used to make the loan came from the proceeds
received by us, its indirect parent company, in the private placement
transaction completed in March 2008.
Exclusive
Purchase Option Agreement
The
Exclusive Purchase Option Agreement, among Speedy Brilliant (Daqing), QKL-China,
and all of the shareholders of QKL-China, provides that QKL-China will grant
Speedy Brilliant (Daqing) or its designated third party an irrevocable and
exclusive right to purchase all or part of QKL-China’s assets, and the
shareholders of QKL-China will grant Speedy Brilliant (Daqing) or its designated
third party an irrevocable and exclusive right to purchase all or part of their
equity interests in QKL-China. Either right may be exercised by Speedy Brilliant
(Daqing) in its sole discretion at any time that the exercise would be
permissible under PRC law, and the purchase price for Speedy Brilliant
(Daqing)’s acquisition of equity or assets will be the lowest price permissible
under PRC law. QKL-China and its shareholders are required to execute purchase
agreements and related documentation within 30 days of receiving notice from
Speedy Brilliant (Daqing) that it intends to exercise its right to
purchase.
The
Exclusive Purchase Option Agreement contains promises from QKL-China and its
shareholders that they will refrain from taking actions, such as voting to
dissolve or declaring dividends, that could impair Speedy Brilliant (Daqing)’s
security interest in the equity of QKL-China or reduce its value. These promises
are substantially the same as those contained in the Loan Agreement described
above.
17
The
agreement will remain effective until Speedy Brilliant (Daqing) or its designees
have acquired 100% of the equity interests of QKL-China or substantially all of
the assets of QKL-China. The exclusive purchase options were granted under the
agreement on the closing date.
Equity
Pledge Agreement
The
Equity Pledge Agreement, among Speedy Brilliant (Daqing), QKL-China, and all of
the shareholders of QKL-China, provides that the shareholders of QKL-China will
pledge all of their equity interests in QKL-China to Speedy Brilliant (Daqing)
as a guarantee of the performance of the shareholders’ obligations and
QKL-China’s obligations under each of the other PRC Restructuring Agreements.
Under the Equity Pledge Agreement, the shareholders of QKL-China have also
agreed (i) to cause QKL-China to have the pledge recorded at the appropriate
office of the PRC Bureau of Industry and Commerce, (ii) to deliver any dividends
received from QKL-China during the term of the agreement into an escrow account
under the supervision of Speedy Brilliant (Daqing), and (iii) to deliver
QKL-China’s official shareholder registry and certificate of equity contribution
to Speedy Brilliant (Daqing).
The
Equity Pledge Agreement contains promises from QKL-China and its shareholders
that they will refrain from taking actions, such as voting to dissolve or
declaring dividends, that could impair Speedy Brilliant (Daqing)’s security
interest in the equity of QKL-China or reduce its value. These promises are
substantially the same as those contained in the Loan Agreement described
above.
Completion
of the PRC Restructuring
The PRC
restructuring transaction closed on March 28, 2008 and after the closing date,
Speedy Brilliant (Daqing) completed all required post-closing steps, including
the payment and verification of all the installments of Speedy Brilliant
(Daqing)’s registered capital.
The
remaining portion of Speedy Brilliant (Daqing)’s registered capital was
contributed and verified by August 1, 2009, two years after the issuance of its
business license.
Share
Exchange Transaction
In the
share exchange transaction, Forme acquired control of Speedy Brilliant (BVI), a
British Virgin Islands holding company and the parent company of Speedy
Brilliant (Daqing), by issuing to the stockholders of Speedy Brilliant (BVI)
shares of common stock in exchange for all of the outstanding capital stock of
Speedy
Brilliant (BVI). The stockholders of Speedy Brilliant (BVI) with whom we
completed the share exchange were (i) the majority holder, Winning State
International Limited, a British Virgin Islands holding company (“Winning State
(BVI)”) all of whose stock may be acquired in the future by our Chief Executive
Officer, Mr. Zhuangyi Wang, pursuant to a currently exercisable call option held
by Mr. Wang and (ii) three minority stockholders, Ms. Fang Chen, Mr. Yang Miao,
and Ms. Ying Zhang. Mr. Wang has exercised his call option and all of the shares
of Winning State (BVI) were transferred from Mr. Yap to Mr. Wang on February 2,
2010.
Share
Exchange Agreement
On March
28, 2008, Forme entered into a share exchange agreement with (i) Speedy
Brilliant (BVI); (ii) Speedy Brilliant (Daqing); (iii) the owners of all of the
outstanding voting stock of Speedy Brilliant (BVI), namely (a) Winning State
(BVI) (a company that is wholly owned and controlled by Mr. Chin Yoke Yap (all
of whose stock was acquired by our CEO, Mr. Zhuangyi Wang, pursuant to a call
option held by Mr. Wang that he exercised on February 2, 2010)), which owned
approximately 98.5% of the Speedy Brilliant (BVI) stock, and (b) three
individuals, Ms. Fang Chen, Ms. Yang Miao and Ms. Ying Zhang, who collectively
owned approximately 1.5% of the Speedy Brilliant (BVI) stock; and (iv) Forme’s
then controlling stockholders, Vision Opportunity China LP, Stallion Ventures,
LLC, and Castle Bison, Inc. Under the terms of the share exchange agreement, the
Speedy Brilliant (BVI) stockholders exchanged all of the outstanding shares of
Speedy Brilliant (BVI) for a total of 19,382,298 newly issued shares of Forme
common stock. As a result of the share exchange, Forme acquired Speedy Brilliant
(BVI) as a wholly owned subsidiary, and the Speedy Brilliant (BVI) stockholders
became holders of 92.8% of our common stock on a non-diluted basis (64.6% of our
common stock assuming conversion of our newly-issued Series A Preferred Stock
and 46.3% of our common stock assuming conversion of our newly-issued Series A
Preferred Stock and exercise of all of the Series A Warrants and Series B
Warrants).
18
In the
PRC restructuring transaction described above, Speedy Brilliant (BVI) gained
control of our operating company, QKL-China. Therefore, when we acquired control
of Speedy Brilliant (BVI) in the share exchange, we acquired indirect control of
QKL-China. As a result, at the time of the share exchange, (i) we ceased to be a
shell company as that term is defined in Rule 12b-2 under the Exchange Act, (ii)
Speedy Brilliant (BVI) became our wholly owned subsidiary, and (iii) through our
newly-acquired indirect subsidiary Speedy Brilliant (Daqing) we now control,
through the contractual arrangements described above.
Our
current structure, after completion of the reverse merger transaction, is set
forth in the diagram below:
Private
Placement Transaction
The other
transaction we completed on March 28, 2008 was a private placement in which we
raised funds through a private sale of securities that was exempt from the
registration requirements under Section 4(2) of the Securities Act as a result
of our compliance with Rule 506 of Regulation D promulgated under the Securities
Act. In the private placement we sold to certain accredited investors, for gross
proceeds to us of $15.5 million, 9,117,647 units, each unit consisting of one
share of Series A Preferred Stock (each of which is convertible into one share
of our common stock), one Series A Warrant and one Series B Warrant (each of
which is exercisable for 0.625 shares of common stock).
The
agreements through which the private placement were carried out are described in
detail below, all of which were entered into on March 28, 2008 unless otherwise
indicated.
Securities
Purchase Agreement
The
securities purchase agreement among Vision Opportunity Master Fund Ltd. (“Vision
Master”), Vision Opportunity China Fund Limited (together with Vision Master,
“Vision”) and certain other investors listed in Exhibit A thereto involved the
sale of an aggregate of 9,117,647 units, each unit consisting of one share of
Series A Preferred Stock, one Series A Warrant and one Series B Warrant. The
closing of the private placement transaction and the securities purchase
agreement was contingent upon and dependent on the closing of the reverse merger
transaction. Each share of Series A Preferred Stock is convertible into one
share of common stock subject to adjustment as described below. Each warrant is
exercisable for 0.625 shares of common stock or an aggregate of up to 11,397,058
shares of common stock. The Series A Warrants are exercisable for up to
5,698,529 shares of common stock and have an exercise price of $3.40 per share,
subject to adjustment. The Series B Warrants are exercisable for up to 5,698,529
shares of common stock and have an exercise price of $4.25 per share, subject to
adjustment. The warrants expire on March 28, 2013, which is five years from the
date of issuance.
19
The terms
of our Series A Preferred Stock are set forth in a Certificate of Designations,
which we filed with the Secretary of State of the State of Delaware on March 13,
2008. For more information regarding the material terms of Series A Preferred
Stock, see the section of this report entitled “Description of our Securities”
under the subheadings “Preferred Stock” and “Terms of Series A Preferred
Stock.”
Securities
Escrow Agreement
The
securities escrow agreement among Vision, as representative of the purchasers
under the securities purchase agreement, Winning State (BVI), and Loeb &
Loeb LLP, as escrow agent, was entered into as an inducement to the purchasers
to enter into the securities purchase agreement. Winning State (BVI) agreed to
deliver 18,235,294 shares of our common stock owned by Winning State (BVI) as
escrow shares (the “Escrow Shares”) to the escrow agent for the benefit of the
purchasers, and to deliver some or all of those shares to the purchasers in the
event the Company fails to achieve certain financial performance thresholds for
the 12-month periods ending December 31, 2008 and December 31,
2009.
The
financial performance thresholds for 2008 required that the Company achieve (i)
both net income and cash from operations greater than $9.4 million and (ii)
fully diluted earnings per share equal to or greater than $0.23. Under the terms
of the agreement these thresholds were met if the Company achieved at least 95%
thereof. The Company reported net income of $9.0 million, cash from operations
of $18.7 million and diluted earnings per share of $0.29 for 2008, and therefore
the thresholds for 2008 were met by the Company. Accordingly, all of the Escrow
Shares remain in escrow, pending the performance of the 2009 performance
thresholds described below.
The
financial performance thresholds for 2009 will be satisfied if the Company
achieves (i) both net income and cash from operations of greater than $11.15
million and (ii) fully diluted earnings per share of $0.27. On April 1, 2010 the
securities escrow agreement was amended to exclude amounts recorded as
liabilities under ASC815. At December 31, 2009, excluding amounts recorded as
liabilities under ASC815, the Company had net income of $10.9 million, cash from
operations of $10.9 million and fully diluted earnings per share of
$0.34.
Because
we achieved at least 95% of each of the 2009 performance thresholds, all of the
2009 escrow shares will be returned to Winning State (BVI). However,
as of the date of this report, the shares have not yet been
returned.
For
purposes of determining the performance thresholds described above, fully
diluted earnings per share was calculated by (x) dividing the lesser of net
income and cash from operations, as reported in our 2009 financial statements
plus any amounts that may have been recorded as charges or liabilities on the
2009 financial statements due to the application of Emerging Issues Task Force
Issue No. 00-19 that are associated with (1) any outstanding warrants issued in
connection with the Securities Purchase Agreement or (2) any liabilities created
as a result of the escrow shares being released to any of our officers or
directors by (y) the aggregate number of shares of our then outstanding common
stock on a fully-diluted basis which number includes, without limitation, the
number of shares of common stock issuable upon conversion of the then
outstanding shares of Series A Preferred Stock and the number of shares of
common stock issuable upon the exercise of any then outstanding preferred stock,
warrants or options of the Company.
Investor
and Public Relations Escrow Agreement
We also
entered into an investor and public relations agreement with Vision Opportunity
China LP, as representative of the purchasers under the securities purchase
agreement, and Loeb & Loeb LLP, as escrow agent. Under the agreement,
$300,000 of the proceeds of the private placement was deposited into an escrow
account with Loeb & Loeb LLP for use in investor and public
relations.
20
Settlement
Agreement
On
January 22, 2008, QKL terminated its engagement agreement with Kuhns Brothers to
provide QKL with investment banking services, on an exclusive basis, with
respect to the private placement transaction and the share exchange transaction,
and the parties executed a settlement agreement. Under the terms of the
settlement agreement, we were required to pay Khuns Brothers (i) a cash fee
equal to 8.5% of the gross proceeds invested in the financing by investors
introduced to the Company by Kuhns Brothers, Inc. (“Introduced Investors”), and
(ii) warrants to purchase up to a number of shares of common stock of the
Company equal to 8.5% of the dollar amount of the shares purchased by the
Introduced Investors divided by the per-share purchase price of the common stock
or preferred stock in the financing. The warrants have the same terms as
warrants received by the Introduced Investors. Accordingly, Kuhns Brothers
received from us a cash fee of $1,300,500, Series A Warrants to
purchase 191,250 shares of our common stock and Series B Warrants to purchase
153,000 shares of our common stock.
Lock-Up
Agreement
In
connection with the private placement we also entered into an agreement with
Winning State (BVI) under which, in order to induce Forme to enter into the
share exchange agreement, certain stockholders including Mr. Zhuangyi Wang, our
CEO and Mr. Xudong Wang, our former CFO, agreed that (i) they would not sell or
transfer any shares of our common stock until at least 12 months after the
effective date of a registration statement filed with the SEC registering for
resale the shares of common stock underlying the Series A Preferred Stock issued
in the private placement transaction and (ii) for an additional 24 months after
the end of that 12 month period, would not sell or transfer more than
one-twelfth of its total shares of that common stock during any one
month.
Agreements
Executed in Connection with Our Public Offering
Waiver
to Registration Rights Agreement
On
October 16, 2009, Vision Opportunity China LP, as representative of the
purchasers listed on Schedule I to the Registration Rights Agreement dated as of
March 28, 2008, agreed to waive the notice and piggyback registration rights
provided by the Registration Rights Agreement solely with respect to this
offering.
Waiver
to Securities Purchase Agreement
On
October 16, 2009, Vision Opportunity China LP, as representative of the
purchasers listed on Schedule A to the Securities Purchase Agreement dated as of
March 28, 2008, agreed to waive the notice and preemption rights provided by the
Securities Purchase Agreement, solely with respect to this
offering.
Amendment
to Securities Escrow Agreement
On
October 15, 2009, we entered into an Amendment to Securities Escrow Agreement,
amending the Securities Escrow Agreement dated March 28, 2008, by and among the
Company, Vision Opportunity China LP as representative of the Purchasers,
Winning State Investment Limited and Loeb & Loeb LLP, as escrow agent, to
revise the definition of “Net income” and “Cash from Operations” for the fiscal
year ended December 31, 2009 to exclude the one time non-recurring cash expenses
incurred by us in connection with this offering and the transactions
contemplated by this offering that were not contemplated by the Securities
Escrow Agreement.
Lock-Up
Letters
On
October 15, 2009, in connection with the offering and in order to induce Roth
Capital Partners, LLC to act as our underwriter, each of our directors and
executive officers, and Winning State (BVI) agreed that, without the prior
written consent of Roth Capital Partners, LLC, they would not, during the period
commencing on October 15, 2009 and ending 180 days after the date of the final
prospectus relating to our public offering (i) either directly or indirectly
sell, pledge, lend or transfer any shares of our common stock or any securities
convertible into or exercisable or exchangeable for our common stock, subject to
certain exclusions, or (ii) make any demand for or exercise any right with
respect to the registration of any shares of common stock or any security
convertible into or exercisable or exchangeable for shares of common
stock.
21
Anti-dilution
Agreements
On March 24, 2010, we entered into a
Warrant Amendment (“Series A Warrant Amendment”) to the Series A Warrant to
Purchase Shares of Common Stock of the Company (“Series A Warrant”) with Vision
Opportunity China LP, pursuant to which certain anti-dilution provisions of the
Series A Warrants were removed on behalf of the Series A Warrant
holders. Pursuant to the Series A Warrant Amendment, we agreed not to
issue any additional shares of common stock or common stock equivalents, except
as otherwise contemplated by the Series A Warrant, at a per share price less
than the exercise price then in effect, without the prior written consent of
holders of a majority of the Series A Warrants at such time.
On March 24, 2010, we entered into a
Warrant Amendment (“Series B Warrant Amendment”) to the Series B Warrant to
Purchase Shares of Common Stock of the Company (“Series B Warrant”) with Vision
Opportunity China LP, pursuant to which certain anti-dilution provisions of the
Series A Warrants were removed on behalf of the Series A Warrant
holders. Pursuant to the Series B Warrant Amendment, we agreed not to
issue any additional shares of common stock or common stock equivalents, except
as otherwise contemplated by the Series B Warrant, at a per share price less
than the exercise price then in effect, without the prior written consent of
holders of a majority of the Series B Warrants at such time.
On March 25, 2010, we entered into a
Waiver (“Waiver”) to the Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock (“Certificate”) with the holders of our
Series A Convertible Preferred Stock, pursuant to which certain anti-dilution
protections of the Certificate were waived. We plan to amend the
Certificate to state that we will not issue any additional shares of common
stock or common stock equivalents, except as otherwise contemplated by the
Certificate, at a conversion price less than the conversion price then in effect
for the Series A Preferred Stock, without the prior written consent of holders
of a majority of the Series A Warrants at such time.
Item
1A. Risk
Factors
An
investment in our common stock involves a high degree of risk. You should
carefully consider the risks described below and the other information contained
in this report before deciding to invest in our common stock.
If
we do not receive prompt delivery of the goods we order, in good condition, and
at the prices we expect, our ability to generate profits could be
harmed.
As a
retail company, our ability to keep our shelves stocked with a wide variety of
merchandise is essential to our success and is dependent on the prompt delivery
of the goods we order, in good condition, and at the prices we expect.
Disruptions to our supply chain could cause us to reduce the variety or overall
amount of goods we sell; to seek alternative sources for affected supplies; or
to increase our prices, decrease our profit margins, or both. Any of these
consequences could lead to our customers buying less, shopping elsewhere or
criticizing our reputation. If this occurred, our income, profitability,
reputation and competitive position would all suffer.
Our
supply chain and costs could be disrupted by a wide variety of events. The most
significant of these are described below:
§
|
Problems
with transportation infrastructure in and around northeastern China and
Inner Mongolia
|
Delivery
of our supplies depends on the smooth passage of commercial cargo through the
railways, highways and waterways in and around northeastern China and Inner
Mongolia. Transportation infrastructure in and around northeastern China and
Inner Mongolia may suffer more breakdowns and offer fewer alternative routes
than systems in many western countries.
§
|
Bad
harvests and severe weather could harm the agricultural production on
which we depend, prevent customers from reaching our stores and disrupt
our power supply
|
Severe
storms could also reduce supplies of fresh foods by destroying crops and
livestock and, in extreme cases, could reduce supplies of processed foods by
reducing overall availability of the agricultural raw materials from which they
are made, and cause shortages of, and price increases for, the affected
supplies.
22
Poor
yields of crops and livestock, whether due to bad weather, disease, errors in
agricultural planning or other causes, could reduce the market supplies of fresh
foods as well as processed foods that depend on agricultural products as raw
materials. Such reductions could raise the cost of our supplies and cause the
supply shortages.
§
|
Quality
control problems and operational difficulties among a small number of
suppliers
|
We rely
on suppliers to provide sufficient amounts of merchandise that meet our quality
standards and government health and consumer-protection standards. A significant
portion of our supplies (approximately 14.7% in 2008 and 9.1% in 2007) come from
our top 10 suppliers, which are primarily large wholesalers and meat processors.
We usually secure a primary vendor and a secondary vendor for each category of
merchandise by entering into standard contracts with them, which typically have
a term of one year and provide for payment at market prices. In case there are
merchandise shortages, we utilize the secondary vendor. If one or more of these
suppliers experiences quality control failures or is unable to secure its own
supply of merchandise, whether self-produced or purchased from others, the
merchandise that it delivers to us could fail to meet our or the government’s
quality standards or arrive in insufficient amounts to meet our needs. If such
risks do materialize, there is no guarantee we would succeed in securing
replacement supplies meeting our and the government’s standards from other
suppliers quickly and at reasonable prices, or at all, and we could suffer the
consequences of supply chain disruption described above.
Under our
supply contracts, our suppliers are responsible for damage that occurs during
shipping and, under the PRC’s consumer protection laws, our suppliers must
reimburse us for the cost of spoiled goods returned tto us by customers for a
refund. Nevertheless, significant spoilage could reduce the amount of fresh food
we are able to offer, which could reduce our income.
§
|
Economic
conditions
|
Economic
conditions, in northeastern China in particular, affect the price and
availability of our supplies. Inflation in prices of agricultural products and
in general is a significant concern in China. If inflation develops and becomes
a significant problem, many retailers in China, including us, will have to
choose between increasing the prices we charge our customers and reducing the
profit margins on our sales. In either case, our competitive position and
operating results could be harmed, and the value of any investment in our common
stock could be reduced.
In
addition, the geographic concentration of our operations exposes us to the risks
of the local economy. We operate in northeastern China and Inner Mongolia, and
our near-term plans call for expansion only within the three provinces of
northeastern China and the eastern region of Inner Mongolia. Our headquarters,
warehouses and distribution facilities and all of our stores are located within
a relatively limited geographic area. As a result, our business is more
susceptible to regional conditions, including conditions affecting
infrastructure, agriculture, inflation and employment, than our more
geographically diversified competitors.
The
supermarket industry in the PRC is becoming increasingly competitive and, unless
we are able to compete effectively with domestic and foreign retailers, and
restaurants and fast food chains, our profits could suffer.
The
supermarket industry in the PRC is highly and increasingly competitive. Giant
international retailers such as Wal-Mart and Carrefour have entered the market,
national retailers such as Bailian and Lianhua have expanded, and local and
regional competition has grown. Some of these companies have substantially
greater financial, marketing, personnel and other resources than we
do.
Our
competitors could adapt more quickly than we do to evolving consumer preferences
or market trends, have more success than we do in their marketing efforts,
control supply costs and operating expenses more effectively than we do, or do a
better job than we do in formulating and executing expansion plans. Increased
competition may also lead to price wars, counterfeit products or negative brand
advertising, all of which may adversely affect our market share and profit
margins. Expansion of large retailers into new locations may limit the locations
into which we may profitably expand. To the extent that our competitors are able
to take advantage of any of these factors, our competitive position and
operating results may suffer.
We also
face heightened competition from restaurants and fast food chains, which are
capturing an increasing portion of household food expenditures in the
PRC.
23
Because
we face intense competition, we must anticipate and quickly respond to changing
consumer demands more effectively than our competitors. In order to succeed in
implementing our business plan, we must achieve and maintain favorable
recognition of our private label brands, effectively market our products to
consumers, competitively price our products, and maintain and enhance a
perception of value for consumers. We must also source and distribute our
merchandise efficiently. Failure to accomplish these objectives could impair our
ability to compete successfully and adversely affect our growth and
profitability.
Our
limited operating history makes it difficult to evaluate our future prospects
and results of operations; our business could fail, and you could lose some or
all of your investment.
We have a
limited operating history and the PRC supermarket industry is young and
continually growing. Accordingly, you should consider our future prospects in
light of the risks and uncertainties experienced by early-stage companies in
evolving markets. Some of these risks and uncertainties relate to our ability
to:
§
|
Offer
new products to attract and retain a larger customer
base;
|
§
|
Respond
to competitive and changing market
conditions;
|
§
|
Maintain
effective control of our costs and
expenses;
|
§
|
Attract
additional customers and increase spending per
customer;
|
§
|
Increase
awareness of our brand and continue to develop customer
loyalty;
|
§
|
Attract,
retain and motivate qualified
personnel;
|
§
|
Raise
sufficient capital to sustain and execute our expansion
plan;
|
§
|
Respond
to changes in our regulatory
environment;
|
§
|
Manage
risks associated with intellectual property rights;
and
|
§
|
Foresee
and understand long-term trends.
|
Because
we are a relatively new company, we may not be experienced enough to address all
the risks in our business or in our expansion plan. If we are unsuccessful in
addressing any of these risks and uncertainties, our business may
fail.
Our
internal control over financial reporting and our disclosure controls and
procedures have been ineffective, and failure to improve them could lead to
future errors in our financial statements that could require a restatement or
untimely filings, which could cause investors to lose confidence in our reported
financial information, and a decline in our stock price.
In
connection with the preparation and audit of our 2009 financial statements and
notes, we were informed by our auditor, BDO China Li Xin Da Hua CPA co. Ltd.
(“BDO”) of certain deficiencies in our internal controls that BDO considered to
be material weaknesses. These deficiencies related to our financial closing
procedures and errors in classification of warrants. After
discussions between management, our audit committee and BDO, we concluded that
the Company had improperly classified warrants pursuant to FASB ASC Topic 815
“Derivatives and Hedging”) (“ASC 815”). As a result of the
reclassification, the Company recognized a $35.5 million loss for the year ended
December 31, 2009.
In
addition, as a result of the reclassification, on March 31, 2009 our audit
committee met with BDO and made a determination that the Company’s financial
statements in each of its quarterly reports filed in 2009 could not be relied on
that it will restate the Company’s financial statement for each of the quarterly
reports it filed in 2009. The Company filed a current
Report on Form 8-K disclosing these determinations under Item 4.02 of Form 8-K
concurrent with the filing of this Annual report.
As
required by Rule 13a-15 promulgated under the Exchange Act, in connection with
the filing of our Annual Report on Form 10-K for the fiscal year ended December
31, 2009, our management, including our chief executive officer and chief
financial officer, evaluated the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) promulgated under the Exchange Act) as of December 31, 2009 and
determined that our disclosure controls and procedures were not effective as of
such date. This conclusion was based on the fact that on December 30,
2009, we entered into an agreement to acquire a building for use as our new
headquarters. Pursuant to Item 1.01 of Form 8-K under the Exchange
Act, we should have filed a current report on Form 8-K disclosing the agreement
by January 6, 2010, but we did not file such current report until January 25,
2010.
As a
result of the material weakness in our internal controls and the ineffectiveness
of our disclosure controls and procedures described above, current and potential
stockholders could lose confidence in our financial reporting, which would harm
our business and the trading price of our stock.
Economic
conditions that affect consumer spending could limit our sales and increase our
costs.
Our
results of operations are sensitive to changes in overall economic conditions
that affect consumer spending, including discretionary spending. Inflation and
adverse changes to employment levels, business conditions, interest rates,
energy and fuel costs and tax rates can, in addition to causing the supply chain
cost challenges described above, reduce consumer spending and change consumer
purchasing habits.
As of the
date of this annual report, we have not been significantly negatively impacted
by the economic downturn in the PRC. The recession in the PRC to date has mainly
impacted the export sector based in southeastern China. Northeastern China and
Inner Mongolia, where our stores are located, have not been affected to the same
extent. Should the economic downturn worsen and spread to northeastern China and
Inner Mongolia, where we are based, a general reduction in the level of consumer
spending in the region would likely result, which would reduce our sales
revenues and profits.
Much
of our income comes from sales of perishable merchandise, which can lose its
value quickly; such losses could harm our operating results.
We could
suffer spoilage if supply chain disruptions occur, if our refrigerators and
freezers malfunction or if we suffer lapses of quality control inspection and
supervision. If our inspections fail to discover spoilage in a shipment of fresh
food or if we fail to routinely inspect perishable merchandise on our shelves,
we could inadvertently offer spoiled food for sale, which could harm our
reputation, competitive position and operating results. Moreover, if we fail to
accurately predict future customer demand for perishable food, we would be
forced to discard unsold perishable food once it spoils, which would also
negatively affect our operating results.
24
Consumer
concerns regarding the safety and quality of food products or health concerns
could adversely affect sales of our high-margin products, which would negatively
impact our profits.
Our sales
results could be harmed if consumers lose confidence in the safety and quality
of our fresh food products. Consumers in the PRC are becoming increasingly
conscious of food safety and nutrition. Consumer concerns about, for example,
the safety of meat, fish, or dairy products, or about the safety of food
additives used in processed food products, could discourage them from buying
these relatively high-margin products and cause our profit margins to fall and
our results of operations to suffer.
We
rely on the performance of our individual stores, individual store managers,
three regional managers and our operating director for our sales, and should any
or all of them perform poorly for any reason, our sales results, reputation and
competitive position would suffer.
We sell
all of our products through our individual stores. Each supermarket is managed
by a store manager who reports directly to one of our three regional managers.
Each regional manager manages around 10 stores and reports to our operating
director, who reports to our COO, Mr. Alan Stewart. Regional managers spend
their time in stores to work together with each individual store manager. Each
region holds teleconferences every week. Although all purchasing decisions as to
vendors and costs are made by company management and not store managers, the
store manager makes the decision as to order quantities and is responsible for
the daily operation of the store. If factors either in or out of a store
manager’s control reduce a store’s business — for example, disruption of
customer traffic by nearby construction or customer dissatisfaction with store
employees — the individual store’s income could fall, which would negatively
impact our sales. Also, if our managers and operating director fail to
adequately manage store employees and day-to-day operations in a manner that
pleases our customers, our reputation and competitive position will
suffer.
We
may fail to identify or anticipate trends in consumer preferences, which could
result in decreased demand for our merchandise, and lower revenues and
profits.
Our
continued success in the retail market depends on our ability to anticipate the
changing tastes, dietary habits and lifestyle preferences of customers. If we
are not able to anticipate and identify new consumer trends and stock our
shelves accordingly, our sales may decline and our operating results may be
adversely affected. For example, we believe meat and dairy products have strong
growth potential in northeastern China and Inner Mongolia. Accordingly, we have
increased our focus on sales of these products, which tend to have higher profit
margins than our other products. If the market for these products in the PRC
does not grow as we expect, our income may not grow as we expect and our
operating results may suffer.
Our
profit margins could narrow and as a result the value of any investment in our
common stock could be reduced.
Profit
margins in the grocery retail industry are narrow. In order to increase or
maintain our profit margins, we are developing strategies to reduce costs by
attempting to increase efficiencies and increase sales of higher-margin items
such as private label merchandise, prepared-in-store foods, and meat and dairy
products, but we can offer no assurance that such strategies, or our execution
of such strategies, will be successful. We also implement promotional price
reductions as part of our competitive strategy that may further affect our
profit margin. Thus, there is no guarantee that our current profit margin will
not decline, which would negatively impact our profitability.
We
rely heavily on information technology systems, which could fail, causing damage
to our operations.
We have a
large and complex information technology system that we rely on to keep track of
inventory and sales, determine our ordering of supplies, and communicate among
stores, our distribution center and our corporate headquarters. Like any
electronic data management system, ours is subject to malfunction. In such a
case, our operations could be significantly disrupted as we work to fix the
problem, upgrade our system or adopt a new system.
In
addition, despite our efforts to secure our computer network, the security of
our network could be compromised, confidential information could be
misappropriated and other system disruptions could occur. This could lead to
loss of sales and diversion of corporate resources from operations and
planning.
25
If
we have difficulties finding and leasing new retail space for new stores or
retaining existing retail space, our operations could be disrupted and we will
be unable to grow as planned, which would negatively affect our stock
price.
We
currently lease the majority of our store locations. Typically our supermarket
leases have initial 10- to 20-year lease terms and may include renewal options
for up to an additional 10 or 20 years. Our revenues and profitability would be
negatively impacted if we are unable to renew these leases at reasonable
rates.
Under our
expansion plan, in 2009 we opened seven new stores that have, in the aggregate,
approximately 32,000square meters of space and, in 2008, we opened 10 new stores
that have, in the aggregate, approximately 42,000 square meters of
space. Our success in executing our expansion plan depends on our
ability to open or acquire new stores in existing and new retail areas and to
operate these stores successfully. We may also choose to continue to expand
through acquisitions. We must find suitable locations for those stores and reach
reasonable terms with building owners and other interested parties, which could
be difficult as we face intense competition from other retailers for such sites.
If we cannot find suitable locations at a reasonable cost, our ability to grow
will be compromised, which would negatively affect our stock price.
Our
insurance coverage may be inadequate and, if any of the products we sell causes
personal injury or illness, we could be exposed to significant losses resulting
from negative publicity and harm to our reputation. This exposure could harm our
business.
The sale
of food products for human consumption involves an inherent risk of injury to
consumers. Such injuries may result from tampering by unauthorized third
parties, contamination, including by bacteria, insecticides, fertilizers and
other substances, spoilage and mislabeling. Although we and our suppliers are
subject to governmental inspections and regulations, consumption of our products
could still cause a health-related illness in the future and we could be subject
to claims or lawsuits relating to such events. Under certain circumstances, we
could be required to recall products. Unlike most supermarket companies in the
United States, but in line with industry practice in the PRC, we do not maintain
product liability insurance, and we cannot predict the extent of liability we
could face if such events were to occur.
Although
the standard contracts we sign with our suppliers include a provision that
shifts liability to our suppliers if a consumer is injured by a supplier’s
product, the negative publicity surrounding any assertions that merchandise we
carry caused personal injury or illness could adversely affect our reputation
and competitive position. In addition, our property and equipment insurance does
not cover the full value of our property and equipment, which leaves us with
exposure in the event of loss or damage to our properties. Except for property,
accident and automobile insurance, we do not have other insurance such as
business liability or disruption insurance coverage for our operations in the
PRC.
We do not
maintain a reserve fund for potential warranty or defective products claims. If
we experience an increase in warranty claims or if our repair and replacement
costs associated with warranty claims increase significantly, our results of
operations and financial condition would suffer.
Our
company name and private label merchandise may be subject to counterfeiting or
imitation, which could damage our reputation and brand image, and lead to higher
administrative costs.
We regard
brand positioning as an important element of our competitive strategy, and
intend to position our private label brands to be associated with low prices,
high quality, convenience and a positive shopping experience. There have been
frequent occurrences of counterfeiting and imitation of products in the PRC in
the past. Imitation of our company name or logo could occur in the future and
there is no guarantee that we will be able to detect it and deal with it
effectively. Any occurrence of counterfeiting or imitation could damage our
corporate and brand image.
If
we do not effectively manage our growth, our expansion efforts could fail, which
would negatively affect our stock price.
There is
no guarantee that our expansion plan will be successfully implemented. In order
to fully implement these plans, we will have to hire a large number of
additional employees, secure new retail locations, and integrate new stores and
distribution routes into our existing business. There is no guarantee that we
will meet all or any of these needs and therefore no guarantee that we will
succeed in our efforts to expand.
26
Moreover,
our future expansion will depend both on the profitability of our business and
our ability to raise capital from outside sources. We intend to finance our
expansion plan, which includes the opening of three additional stores during the
remainder of 2009, from funds generated from operations, bank loans, and
proceeds from this offering.
If our
business and markets grow and develop, it will be necessary for us to finance
and manage expansion in an orderly fashion. We may not have the requisite
experience to manage and operate a larger network of stores and distribution
centers. In addition, we may face challenges in integrating acquired businesses
with our own. These events would increase demands on our existing management,
workforce and facilities. Failure to satisfy these increased demands could
interrupt or adversely affect our operations and cause production backlogs,
longer product development time frames and administrative
inefficiencies.
If our
expansion plans are not fulfilled, our stock price will decline.
We
may not be able to hire and retain qualified personnel to support our growth and
if we are unable to retain or hire such personnel in the future, our ability to
implement our business objectives could be limited. Difficulties with hiring,
employee training and other labor issues could disrupt our
operations.
Our
operations depend on the work of nearly 3,900 employees. We may not be able to
retain those employees, successfully hire and train new employees or integrate
new employees into the programs and policies of the Company. Any such
difficulties would reduce our operating efficiency and increase our costs of
operations, and could harm our overall financial condition.
If one or
more of our senior executives or other key personnel are unable or unwilling to
continue in their present positions, we may not be able to replace them within a
reasonable time, and our business may be disrupted and our financial condition
and results of operations may be materially and adversely affected. Competition
for senior management and personnel is intense, the pool of qualified candidates
is very limited, and we may not be able to retain the services of our senior
executives or senior personnel, or attract and retain high-quality senior
executives or senior personnel in the future. This failure could limit our
future growth and reduce the value of our common stock.
We
may have difficulty establishing adequate management, legal and financial
controls in the PRC, which may result in a material misstatement of our annual
or interim consolidated financial statements.
Companies
in the PRC have not historically adopted a western style of management and
financial reporting concepts and practices, or a modern western style of
banking, computer and other control systems. We may have difficulty in hiring
and retaining a sufficient number of employees qualified in these areas to work
for our operating company in the PRC. As a result of these factors, we may
experience difficulty in establishing management, legal and financial controls,
collecting financial data, preparing financial statements, books of account and
corporate records, and instituting business practices relating to our PRC
operations that meet western standards. Any such difficulty could result in a
material misstatement of our annual or interim consolidated financial
statements.
We
could be required to pay liquidated damages to our investors under the
registration rights agreement entered into with our investors and such payment
could harm our financial condition.
On March
28, 2008, as part of a $15.5 million private placement, we entered into a
registration rights agreement (as amended on May 8, 2008) with certain
investors, pursuant to which we agreed to register for resale up to an aggregate
of 41,495,261 shares of common stock, including shares of common stock
underlying Series A Preferred Stock, Series A Warrants and Series B Warrants.
The registration rights agreement provided that if the initial registration
statement required to be filed thereunder was not declared effective by
September 24, 2008, we would be required to pay certain liquidated damages to
the investors. On March 9, 2009, the investors party to the registration rights
agreement waived their right to such liquidated damages and on August 11, 2009,
the initial registration statement covering 2,070,836 shares of the total shares
registrable pursuant to the registration rights agreement was declared
effective. We were not able to register all of the 41,495,261 shares in the
initial registration statement due to limits imposed by the Securities Exchange
Commission’s interpretation of Rule 415 of Regulation C promulgated under the
Securities Act of 1933, as amended (the “ Securities Act
“).
There are
additional deadlines we are required to meet if the private placement investors
request that we file one or more registration statements covering the remaining
shares that we are obligated to register pursuant to the registration rights
agreement. If we fail to meet one or more of those deadlines, we would, in the
absence of an additional waiver, be required to pay the investors up to a
maximum of $1,550,000 in liquidated damages. Payment of a significant amount of
liquidated damages would harm our profitability and we may not have sufficient
cash to pay them.
27
If
our lease agreements for certain stores are nullified due to title deficiencies
of our landlords, our business may be adversely affected.
The PRC
real property laws and regulations require landlord to be the legal owner of the
relevant leased properties, otherwise the lease agreement may be nullified. We
have not received or confirmed documentation evidencing our landlord’s legal
ownership for 14 of our stores. If any of these landlords do not legally own the
leased properties, the actual legal owners could force the affected stores to
relocate and operation of the stores concerned may be temporarily terminated
until such stores are relocated.
In
addition, the PRC real property laws and regulations require landlords to obtain
prior consent from the legal owner of the relevant leased properties before the
execution of any sublease agreements; otherwise the sublease agreement may be
nullified if the legal owner refuses to rectify his consent. We have not
independently confirmed whether consents authorizing our subleases for our
supermarkets and distribution centers have been obtained. If the legal owners of
the stores claim that the subleases were invalid, operation of the supermarkets
or distribution centers concerned may be terminated until the supermarkets or
distribution centers are relocated.
Some
of our stores may not be in full compliance with legal requirement on their
sector approvals and business licenses and may therefore be subject to
punishment imposed by the relevant PRC authorities.
The PRC
laws and regulations require that store operators obtain a Public Site Hygiene
License and, if applicable, a Food Hygiene License if there are edible products
being processed or distributed in the store. Store operators are also required
to indicate “store operation” on the Public Site Hygiene License and to specify
each category of edible product (i.e., vegetables, fresh seafood, etc.)
distributed. Failure to do so may expose the store to administrative punishments
imposed by the relevant government authorities. Punishments include
administrative penalty up to RMB20,000 (approximately US$3,000), confiscation of
income generated from the excluded business items and, in extreme cases,
revocation of the business license of the violating store.
Several
of our stores have either not obtained the Public Site Hygiene License or are
distributing edible products without specifying the product category on their
Food Hygiene License. Such stores may be subject to sanction as discussed above,
which may be imposed at the sole discretion of PRC authorities.
In
addition, several of our stores are distributing products salt, alcohol,
audio-video products and tobacco which are not permitted on their business
license. While such stores have not been sanctioned for such discrepancy, we
cannot guaranty that the relevant PRC authority will not impose administrative
penalties on such stores in the future, which penalties could be up to
RMB100,000 (approximately US$15,000) per store.
We
are not current in our payment of social insurance and housing accumulation fund
for our employees and such shortfall may expose us to relevant administrative
penalties.
The PRC
laws and regulations require all the employers in China to fully contribute
their own portion of the social insurance premium and housing accumulation fund
for their employees within a certain period of time. Failure to do so may expose
the employers to make rectification for the accrued premium and fund by the
relevant labour authority. Also, an administrative fine may be imposed on the
employers as well as the key management members. Speedy Brilliant (Daqing),
QKL-China and QT&C have failed to fully contribute the social insurance
premium and housing accumulation fund. Therefore, they may be subject to the
administrative punishment as mentioned above.
Risks
Related to Our Corporate Structure
We
control QKL-China through a series of contractual arrangements, which may not be
as effective in providing control over the entity as direct ownership and may be
difficult to enforce.
We
operate our business in the PRC through our variable interest entity, QKL-China.
QKL-China holds the licenses, approvals and assets necessary to operate our
business in the PRC. We have no equity ownership interest in QKL-China and rely
on contractual arrangements with QKL-China and its shareholders that allow us to
substantially control and operate QKL-China. These contractual arrangements may
not be as effective as direct ownership in providing control over QKL-China
because QKL-China or its shareholders could breach the
arrangements.
28
Our
contractual arrangements with QKL-China are governed by PRC law and provide for
the resolution of disputes through arbitration in the PRC. Accordingly, these
contracts would be interpreted in accordance with PRC law and any disputes would
be resolved in accordance with PRC legal procedures. If QKL-China or its
shareholders fail to perform their respective obligations under these
contractual arrangements, we may have to
§
|
incur
substantial costs to enforce such arrangements,
and
|
§
|
rely
on legal remedies under PRC law, including seeking specific performance or
injunctive relief, and claiming
damages.
|
The legal
environment in the PRC is not as developed as in the United States and
uncertainties in the Chinese legal system could limit our ability to enforce
these contractual arrangements. In the event that we are unable to enforce these
contractual arrangements, our business, financial condition and results of
operations could be materially and adversely affected.
If
the PRC government determines that the contractual arrangements through which we
control QKL-China do not comply with applicable regulations, our business could
be adversely affected.
Although
we believe our contractual relationships through which we control QKL-China
comply with current licensing, registration and regulatory requirements of the
PRC, we cannot assure you that the PRC government would agree, or that new and
burdensome regulations will not be adopted in the future. If the PRC government
determines that our structure or operating arrangements do not comply with
applicable law, it could revoke our business and operating licenses, require us
to discontinue or restrict our operations, restrict our right to collect
revenues, require us to restructure our operations, impose additional conditions
or requirements with which we may not be able to comply, impose restrictions on
our business operations or on our customers, or take other regulatory or
enforcement actions against us that could be harmful to our
business.
The
controlling shareholders of QKL-China have potential conflicts of interest with
us, which may adversely affect our business.
The
controlling shareholders of QKL-China are also beneficial holders of our common
shares. They are also directors of both QKL-China and us. These shareholders
hold a larger interest in QKL-China when compared to their beneficial ownership
in our shares. Conflicts of interest between their dual roles as shareholders
and directors of both QKL-China and us may arise. We cannot assure you that when
conflicts of interest arise, any or all of these individuals will act in the
best interests of the Company or that conflicts of interest will be resolved in
our favor. In addition, these individuals may breach or cause QKL-China to
breach or refuse to renew the existing contractual arrangements that allow us to
receive economic benefits from QKL-China. Currently, we do not have existing
arrangements to address potential conflicts of interest between these
individuals and our company. We rely on these individuals to abide by the laws
of the State of Delaware, which provide that directors owe a fiduciary duty to
the Company, and which require them to act in good faith and in the best
interests of the Company, and not use their positions for personal gain. If we
cannot resolve any conflicts of interest or disputes between us and the
shareholders of QKL-China, we would have to rely on legal proceedings, which
could result in disruption of our business and substantial uncertainty as to the
outcome of any such legal proceedings.
Risks
Related to Doing Business in the People’s Republic of China
Our
business operations are conducted entirely in the PRC. Because China’s economy
and its laws, regulations and policies are different from those typically found
in western countries and are continually changing, we will face risks including
those summarized below.
The
PRC is a developing nation governed by a one-party government and may be more
susceptible to political, economic, and social upheaval than other nations; any
such upheaval could cause us to temporarily or permanently cease
operations.
China is
a developing country governed by a one-party government that imposes
restrictions on individual liberties that are significantly stricter than those
typically found in western nations. China has an extremely large population,
significant levels of poverty, widening income gaps between rich and poor and
between urban and rural residents, large minority ethnic and religious
populations, and growing access to information about the different social,
economic, and political systems to be found in other countries. China has also
experienced rapid economic growth over the last decade, and its legal and
regulatory systems have changed rapidly to accommodate this growth. These
conditions make China unique and may make it susceptible to major structural
changes. Such changes could include a reversal of China’s movement to encourage
private economic activity, labor disruptions or other organized protests,
nationalization of private businesses, internal conflicts between the police or
military and the citizenry, and international political or military conflict. If
any of these events were to occur, it could damage China’s economy and impair
our business.
29
We
are subject to comprehensive regulation by the PRC legal system, which is
uncertain. As a result, it may limit the legal protections available to you and
us and we may not now be, or remain in the future, in compliance with PRC laws
and regulations.
QKL-China,
our operating company, is incorporated under and is governed by the laws of the
PRC; all of our operations are conducted in the PRC; and our suppliers and the
agricultural producers on whom they depend are all located in the PRC. The PRC
government exercises substantial control over virtually every sector of the PRC
economy, including the production, distribution and sale of our merchandise. In
particular, we are subject to regulation by local and national branches of the
Ministries of Agriculture, Commerce and Health, as well as the General
Administration of Quality Supervision, the State Administration of Foreign
Exchange, and other regulatory bodies. In order to operate under PRC law, we
require valid licenses, certificates and permits, which must be renewed from
time to time. If we were to fail to obtain the necessary renewals for any
reason, including sudden or unexplained changes in local regulatory practice, we
could be required to shut down all or part of our operations temporarily or
permanently.
QKL-China
is subject to PRC accounting laws, which require that an annual audit be
performed in accordance with PRC accounting standards. The PRC foreign-invested
enterprise laws require that our subsidiary, Speedy Brilliant (Daqing), submit
periodic fiscal reports and statements to financial and tax authorities and
maintain its books of account in accordance with Chinese accounting laws. If PRC
authorities were to determine that we were in violation of these requirements,
we could lose our business license and be unable to continue operations
temporarily or permanently.
The legal
and judicial systems in the PRC are still rudimentary. The laws governing our
business operations are sometimes vague and uncertain and enforcement of
existing laws is inconsistent. Thus, we can offer no assurance that we are, or
will remain, in compliance with PRC laws and regulations.
PRC
regulations also involve complex procedures for acquisitions conducted by
foreign investors that could make it more difficult for us to grow through
acquisitions.
The New
M&A Rules also established additional procedures and requirements that are
expected to make merger and acquisition activities in China by foreign investors
more time-consuming and complex, including requirements in some instances that
the MOFCOM be notified in advance of any change-of-control transaction in which
a foreign investor takes control of a PRC domestic enterprise, or that the
approval from the MOFCOM be obtained in circumstances where overseas companies
established or controlled by PRC enterprises or residents acquire affiliated
domestic companies and special anti-monopoly submissions for parties meeting
certain reporting thresholds. We may grow our business in part by acquiring
other retail companies. Complying with the requirements of the new regulations
to complete such transactions could be time-consuming, and any required approval
processes, including approval from MOFCOM, may delay or inhibit our ability to
complete such transactions, which could affect our ability to expand our
business or maintain our market share.
The new
regulations also established additional procedures and requirements that are
expected to make merger and acquisition activities in China by foreign investors
more time-consuming and complex, including requirements in some instances that
the MOFCOM be notified in advance of any change-of-control transaction in which
a foreign investor takes control of a PRC domestic enterprise, or that the
approval from the MOFCOM be obtained in circumstances where overseas companies
established or controlled by PRC enterprises or residents acquire affiliated
domestic companies. We may grow our business in part by acquiring other retail
companies. Complying with the requirements of the new regulations to complete
such transactions could be time-consuming, and any required approval processes,
including approval from MOFCOM, may delay or inhibit our ability to complete
such transactions, which could affect our ability to expand our business or
maintain our market share.
In
addition, on February 2, 2010, our Chief Executive Officer, Mr. Wang, acquired
all of the shares of Winning State (BVI), which currently owns 19,082,299 shares
(approximately 64.4%) of our common stock, through a call option. While it is
the case that our PRC counsel Deheng Law Firm believes that this arrangement was
lawful under PRC laws and regulations, there are substantial uncertainties
regarding the interpretation and application of the current or future PRC laws
and regulations, including regulations governing the validity and legality of
such call options. Accordingly, we cannot assure you that PRC government
authorities will not ultimately take a view contrary to the opinion of our PRC
legal counsel.
30
PRC
laws and regulations governing our businesses and the validity of certain of our
contractual arrangements are uncertain. If we are found to be in violation, we
could be subject to sanctions. In addition, changes in such PRC laws and
regulations may materially and adversely affect our business.
We do not
currently have any equity interest in QKL-China or its subsidiary, but instead
enjoy economic benefits and control over these entities substantially similar to
equity ownership through contractual arrangements among our wholly-owned
subsidiary in China, Speedy Brilliant (Daqing), QKL-China and their respective
shareholders. Consistent with the provisions of Financial Accounting Standard
Board “FASB” Interpretation No. 46 (revised), “Consolidation of Variable
Interest Entities — an Interpretation of ARB No. 51”, we consolidated QKL-China
from its inception.
There are
substantial uncertainties regarding the interpretation and application of the
current or future PRC laws and regulations, including regulations governing the
validity and enforcement of such contractual arrangements. Accordingly, we
cannot assure you that PRC government authorities will not ultimately take a
view contrary to the opinion of our PRC legal counsel and Albert Wong & Co.
that we have properly consolidated QKL-China from its inception.
The PRC
government has broad discretion in dealing with violations of laws and
regulations, including levying fines, revoking business and other licenses,
proscribing remittance of profits offshore and requiring actions necessary for
compliance. In particular, licenses and permits issued or granted to us by
relevant governmental bodies may be revoked at a later time by higher regulatory
bodies. We cannot predict the effect of the interpretation of existing or new
PRC laws or regulations on our businesses. We cannot assure you that our current
ownership and operating structure would not be found to be in violation of any
current or future PRC laws or regulations. As a result, we may be subject to
sanctions, including fines, and could be required to restructure our operations
or cease to provide certain services. Any of these or similar actions could
significantly disrupt our business operations or restrict us from conducting a
substantial portion of our business operations, which could materially and
adversely affect our business, financial condition and results of
operations.
Anti-inflation
measures could harm the economy generally and could harm our
business.
The PRC
government exercises significant control over the PRC economy. In recent years,
the PRC government has instituted measures to curb the risk of inflation. These
measures have included devaluations of the RMB, restrictions on the availability
of domestic credit, and limited re-centralization of the approval process for
some international transactions. These measures may not succeed in controlling
inflation, or they may slow the economy below a healthy growth rate and lead to
economic stagnation or recession; in the worst-case scenario, the measures could
slow the economy without curbing inflation, causing “stagflation.” The PRC
government could adopt additional measures to further combat inflation,
including the establishment of price freezes or moratoriums on certain projects
or transactions. Such measures could harm the economy generally and hurt our
business by limiting the income of our customers available to purchase our
merchandise, by forcing us to lower our profit margins, and by limiting our
ability to obtain credit or other financing to pursue our expansion plan or
maintain our business.
Governmental
control of currency conversions could prevent us from paying
dividends.
All of
our revenue is earned in RMB and current and future restrictions on currency
conversions may limit our ability to use revenue generated in RMB to make
dividend or other payments in United States dollars. Although the PRC government
introduced regulations in 1996 to allow greater convertibility of the RMB for
current account transactions, significant restrictions still remain, including
the restriction that foreign-invested enterprises like us may buy, sell or remit
foreign currencies only after providing valid commercial documents at a PRC
banks specifically authorized to conduct foreign-exchange business.
In
addition, conversion of RMB for capital account items, including direct
investment and loans, is subject to governmental approval in the PRC, and
companies are required to open and maintain separate foreign-exchange accounts
for capital account items. There is no guarantee that PRC regulatory authorities
will not impose additional restrictions on the convertibility of the RMB. These
restrictions could prevent us from distributing dividends and thereby reduce the
value of our stock.
31
Fluctuation
in the exchange rate of the RMB against the United States dollar could result in
foreign currency exchange losses.
In 2005,
the PRC government changed its decade-old policy of pegging the value of the RMB
to the United States dollar. Under the new policy, the RMB is permitted to
fluctuate within a narrow and managed band against a basket of certain foreign
currencies. This change in policy has resulted in an appreciation of the RMB
against the United States dollar of approximately 17.5% from July 1, 2005
through September 1, 2009. There remains significant international pressure on
the PRC government to adopt an even more flexible currency policy, which could
result in a further and more significant appreciation of the RMB against the
United States dollar.
The value
of our common stock will be affected by the foreign exchange rate between United
States dollars and RMB. For example, to the extent that we need to convert
United States dollars we receive from an offering of our securities into RMB,
appreciation of the RMB against the United States dollar could reduce the value
in RMB of our proceeds. Conversely, if we decide to convert our RMB into United
States dollars for the purpose of declaring dividends on our common stock or for
other business purposes, and the United States dollar appreciates against the
RMB, the United States dollar equivalent of our earnings from our business would
be reduced. In addition, the depreciation of significant United States
dollar-denominated assets could result in a charge to our income statement and a
reduction in the value of these assets.
The
RMB is not a freely convertible currency, which could limit our ability to
obtain sufficient foreign currency to support our business operations in the
future.
We
receive all of our revenues in RMB. The PRC government imposes controls on the
convertibility of RMB into foreign currencies and, in certain cases, the
remittance of currency out of the PRC. Shortages in the availability of foreign
currency may restrict our ability to remit sufficient foreign currency to pay
dividends, or otherwise satisfy foreign currency denominated obligations. Under
existing PRC foreign exchange regulations, payments of current account items,
including profit distributions, interest payments and expenditures from the
transaction, can be made in foreign currencies without prior approval from SAFE
by complying with certain procedural requirements. However, approval from
appropriate governmental authorities is required where RMB are to be converted
into foreign currency and remitted out of the PRC to pay capital expenses, such
as the repayment of bank loans denominated in foreign currencies.
The PRC
government could restrict access in the future to foreign currencies for current
account transactions. If the foreign exchange control system prevents us from
obtaining sufficient foreign currency to satisfy our currency demands, we may
not be able to pay certain expenses as they come due.
Our
PRC stockholders are required to register with SAFE; their failure to do so
could cause us to lose our ability to remit profits out of the PRC as
dividends.
SAFE has
promulgated several regulations, including Circular No. 75 (“Circular 75”),
which became effective in November 2005, requiring PRC residents, including both
PRC legal person residents and PRC natural person residents, to register with
the competent local SAFE branch before establishing or controlling any company
outside of the PRC for the purpose of equity financing with assets or equities
of PRC companies, referred to in the Circular 75 as an “offshore special purpose
company.” PRC residents that have established or controlled an offshore special
purpose company, which has finished a round-trip investment before the
implementation of Circular 75, are required to register their ownership
interests or control in such “special purpose vehicles” with the local offices
of SAFE. Under Circular 75, the term “PRC legal person residents” as used in
Circular 75 refers to those entities with legal person status or other economic
organizations established within the territory of the PRC. The term “PRC natural
person residents” as used in Circular 75 includes all PRC citizens and all other
natural persons, including foreigners, who habitually reside in the PRC for
economic benefit. The term “special purpose vehicle” refers to an offshore
entity established or controlled, directly or indirectly, by PRC residents or
PRC entities for the purpose of seeking offshore equity financing using assets
or interests owned by such PRC residents or PRC entities in onshore companies,
and the term “round-trip investment” refers to the direct investment in PRC by
PRC residents through “special purpose vehicles,” including without limitation,
establishing foreign invested enterprises and using such foreign invested
enterprises to purchase or control (by way of contractual arrangements) onshore
assets.
In
addition, any PRC resident that is the shareholder of an offshore special
purpose company is required to amend his/her/its SAFE registration with the
local SAFE branch upon (i) injection of equity interests or assets of an onshore
enterprise to the offshore entity, or (ii) subsequent overseas equity financing
by such offshore entity. PRC residents are also required to complete amended
registrations or filing with the local SAFE branch within 30 days of any
material change in the shareholding or capital of the offshore entity not
involving a round-trip investment, such as changes in share capital, share
transfers and long-term equity or debt investments or, already organized or
gained control of offshore entities that have made onshore investments in the
PRC before Circular 75 was promulgated must register with their shareholdings in
the offshore entities with the local SAFE branch on or before March 31,
2006.
32
Under
Circular 75, PRC residents are further required to repatriate into the PRC all
of their dividends, profits or capital gains obtained from their shareholdings
in the offshore entity within 180 days of their receipt of such dividends,
profits or capital gains. The registration and filing procedures under the
Circular 75 are prerequisites for other approval and registration procedures
necessary for capital inflow from the offshore entity, such as inbound
investments or shareholders loans, or capital outflow to the offshore entity,
such as the payment of profits or dividends, liquidating distributions, equity
sale proceeds, or the return of funds upon a capital reduction.
To
further clarify the implementation of Circular 75, SAFE issued Circular No. 106
(“Circular 106”) on May 9, 2007, which is a guidance that SAFE issued to its
local branches with respect to the operational process for SAFE registration
that standardizing mores specific and stringent supervision on the registration
relating to the Circular 75. Under Circular 106, PRC subsidiaries of an offshore
special purpose company are required to coordinate and supervise the filing of
SAFE registrations by the offshore holding company’s shareholders who are PRC
residents in a timely manner. If these shareholders and/or beneficial owners
fail to comply, the PRC subsidiaries are required to report such failure to the
local SAFE authorities and, if the PRC subsidiaries do report the failure, the
PRC subsidiaries may be exempted from any potential liability to them related to
the stockholders’ failure to comply. The failure of these shareholders and/or
beneficial owners to timely amend their SAFE registrations pursuant to the
Circular 75 and Circular 106 or the failure of future shareholders and/or
beneficial owners of our company who are PRC residents to comply with the
registration procedures set forth in the Circular 75 and Circular 106 may
subject such shareholders, beneficial owners and/or our PRC subsidiaries to
fines and legal sanctions and may also limit our ability to contribute
additional capital into our PRC subsidiaries, limit our PRC subsidiaries ability
to distribute dividends to our company or otherwise adversely affect our
business.
These
regulations apply to our stockholders who are PRC residents. In the event that
our PRC-resident stockholders do not follow the procedures required by SAFE, we
could (i) be exposed to fines and legal sanctions, (ii) lose the ability to
contribute additional capital into our PRC subsidiaries or distribute dividends
to our company, (iii) face liability for evasion of foreign-exchange
regulations, and/or (iv) lose the ability to consolidate the financial
statements of our PRC subsidiaries and of QKL-China under applicable accounting
principals.
Mr. Wang,
our Chief Executive Officer, is required to register with the competent SAFE
branch prior to exercise of his call option, and he completed such registration
on October 10, 2009. Mr. Wang has exercised his call option and all of the
shares of Winning State (BVI) were transferred from Mr. Yap to Mr. Wang on
February 2, 2010..
Enforcement
against us or our directors and officers may be difficult and you could be
unable to collect amounts due to you in the event that we or any officer or
director violates applicable law.
Our
operating company, QKL-China, is located in the PRC and substantially all of our
assets are located in the PRC. Most of our current officers and directors are
residents of the PRC, and most of their assets are located in the PRC. As a
result, it could be difficult for investors to effect service of process on us
or those persons in the United States, or to enforce a judgment obtained in the
United States against us or any of these persons.
Health
problems in the PRC could negatively affect our operations.
A renewed
outbreak of severe acute respiratory syndrome, or SARS, or another widespread
public health problem in the PRC, such as bird flu, could have an adverse effect
on our ability to receive and distribute merchandise, the ability of our
employees and customers to reach our stores, and other aspects of our
operations. Public-safety measures such as quarantines or closures of some
stores could disrupt our operations. Any of the foregoing events or other
unforeseen consequences of public health problems could adversely affect our
business.
33
Risks
Related to an Investment in Our Common Stock
Our
Chief Executive Officer beneficially owns a significant portion of our common
stock and will be able to exert significant influence over us through his
position and stock ownership; his interests may differ from yours, and he could
cause us to take actions that are contrary to your interests and that could
reduce the value of your stock.
Our Chief
Executive Officer, Mr. Wang, owns all of the shares of Winning State (BVI),
which currently owns 19,082,299 shares (approximately 64.4%) of our common
stock. Even assuming conversion of all of the outstanding Series A Preferred
Stock and the exercise of all of the Series A Warrants and Series B Warrants,
Mr. Wang will own a significant portion of our outstanding common stock. As a
result, Mr. Wang will be able to influence the outcome of stockholder votes on
various matters, including the election of directors and extraordinary corporate
transactions such as business combinations. In any such stockholder vote, Mr.
Wang’s interests may differ from that of other stockholders, and he could cause
us to take actions that are contrary to your interests and that could reduce the
value of your stock.
We
do not intend to pay cash dividends in the foreseeable future; this may affect
the price of our stock.
We
currently intend to retain all future earnings for use in the operation and
expansion of our business. We do not intend to pay any cash dividends in the
foreseeable future but will review this policy as circumstances dictate. Should
we decide in the future to do so, as a holding company, our ability to pay
dividends and meet other obligations depends upon the receipt of dividends or
other payments from Speedy Brilliant (Daqing). Speedy Brilliant (Daqing) may,
from time to time, be subject to restrictions on its ability to make
distributions to us, including as a result of restrictions on the conversion of
local currency into United States dollars or other hard currency and other
regulatory restrictions. (See “Risks related to doing business in the People’s
Republic of China” above.) In addition, under the terms of the securities
purchase agreement relating to the private placement, as long as any Series A
Preferred Stock remains outstanding, the Company cannot pay any dividends on the
common stock unless such dividends are also paid to the holders of the Series A
Preferred Stock.
Our
common stock is illiquid and subject to price volatility unrelated to our
operations and could lose some or all of its value even if our business is
strong.
The
market price of our common stock could fluctuate substantially in the future due
to a variety of factors, including the market perception of our ability to
achieve our planned growth, quarterly operating results of other companies in
the same industry, trading volume in our common stock, changes in general
conditions in the economy and the financial markets or other developments
affecting our competitors or us. The failure to establish and maintain an active
trading market for our common stock may adversely affect our shareholders’
ability to sell our common stock in short periods of time, or at all. Trading of
our common stock has been sporadic and our common stock has experienced, and may
experience in the future, significant price and volume fluctuations. Future
sales of substantial amounts of our common stock in the trading market could
adversely affect market prices.
The
resale in the public market of the shares underlying the Series A Preferred
Stock and Series A Warrants and Series B Warrants issued in the March 2008
private placement and of the shares acquired prior to the private placement may
cause the market value of our common stock to fall.
In August
2009 we registered for resale 2,070,836 shares of our common stock by certain
selling stockholders. As of March 29, 2009, there were issued and outstanding
(i) 29,653,431 shares of common stock, (ii) 7,370,898 shares of Series A
Preferred Stock (convertible into 7,370,898 shares of common stock); (iii)
Series A Warrants to purchase 5,789,705 shares of common stock; and (iv) Series
B Warrants to purchase 5,771,470 shares of common stock. Assuming conversion of
all of the Series A Preferred Stock and exercise of all of the Series A Warrants
and Series B Warrants, there will be 48,585,504 shares of common stock
outstanding. Many of our shares, including all of the shares underlying the
Series A Preferred Stock, are currently eligible for resale under Rule 144. As
of the date of this annual report the shares underlying the Series A and Series
B Warrants were eligible for resale under Rule 144.
Also, as
a result of our public offering of 6,900,000 shares of common stock,
there is a significant number of new shares of common stock in the market. Sales
of substantial amounts of common stock, or the perception that such sales could
occur under Rule 144 or otherwise, and the existence of warrants to purchase
shares of common stock at prices that may be below the then current market price
of the common stock, could reduce the market price of our common stock and could
impair our ability to raise capital through the sale of our equity
securities.
34
Item
1B. Unresolved
Staff Comments
Not
Applicable.
Item
2. Properties
All land
in the PRC is owned by the government and cannot be sold to any individual or
entity. Instead, the government grants or allocates landholders a “land use
right,” which we sometimes refer to informally as land ownership. There are four
ways of acquiring land use rights in the PRC:
§
|
Grant
of the right to use land;
|
§
|
Assignment
of the right to use land;
|
§
|
Lease
of the right to use land; and
|
§
|
Allocation
of the right to use land.
|
Granted
land use rights are provided by the government in exchange for a grant fee, and
carry the rights to pledge, mortgage, lease and transfer the land within the
term of the grant. Land is granted for a fixed term, generally 70 years for
residential use, 50 years for industrial use, and 40 years for commercial and
other use. The term is renewable in theory. Unlike in western nations, granted
land must be used for the specific purpose for which it was
granted.
Allocated
land use rights are generally provided by the government for an indefinite
period (usually to state-owned entities) and cannot be pledged, mortgaged,
leased, or transferred by the user unless otherwise approved by the competent
government authorities. Allocated land can be reclaimed by the government at any
time. Allocated land use rights may be converted into granted land use rights
upon the payment of a grant fee to the government.
We have
land use rights to our headquarters and two other stores; we lease our 31 other
retail locations and our distribution center. Most of our lease agreements have
a typical term of 8 to 15 years, and most of our leased properties have a fixed
rent based on a price per square meter, which cannot be raised during the term
of the lease.
Our land
use rights are set forth below:
Land
Use Rights Acquired through Grants from Land Management Authority
Land No.
|
No. 1
|
No.2
|
||
Land
Use Right Certificate No.
|
Daqing
Guo Yong (2006)
No.
001485
|
Daqing
Guo Yong (2006)
No.
001488
|
||
User
of the Land
|
Qingkelong
|
Qingkelong
|
||
Location
|
North
Building 3-23,
East
Jing Qi Street,
Dongfeng
Xincun Village
|
Building
3-36A
East
Jing Qi Street,
Dongfeng
Xincun Village,
Sartu
District
|
||
Usage
|
Commercial
Use
|
Commercial
Use
|
||
Area
(square meters)
|
3193.70
|
34.30
|
||
Form
of Acquisition
|
From
related land authority
|
From
related land authority
|
||
Expiration
Date
|
2044-6-27
|
2044-6-27
|
||
Encumbrances
|
None
|
None
|
35
Land
Use Rights Acquired by Transfer
Land No.
|
No. 1
|
No.2
|
No.3
|
|||
Land
Use Right
Certificate
No.
|
Daqing
Guo Yong (2008) No. 02-31415
|
Daqing
Guo Yong (2008) No. 02-31383
|
Daqing
Guo Yong
(2008)
No. 02-31396
|
|||
User
of the Land
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
|||
Location
|
No.
44 of Jingqi Street, Dongfeng Xincun,
Sartu
District
|
No.
44 of Jingqi Street, Dongfeng Xincun,
Sartu
District
|
Shangfu
No.4 Building 7, Wanbao No. 2
Community
Sartu District
|
|||
Usage
|
Commercial
Use
|
Commercial
Use
|
Commercial
Use
|
|||
Area
(square meters)
|
68.5
|
503.6
|
1,242.58
|
|||
Form
of Acquisition
|
Transferred
Land
|
Transferred
Land
|
Transferred
Land
|
|||
Expiration
Date
|
2043-6-19
|
2043-6-19
|
2048-3-10
|
|||
Encumbrances
|
None
|
None
|
None
|
* There
are mortgages on this land, which encumber the land use rights.
Owned
Premises
|
1
|
2
|
3
|
4
|
||||
Certificate
No.
|
Qing
Fang Quan Zheng Sartu District Zi
No.
NA337278
|
Qing
Fang Quan Zheng Sartu District Zi
No.
NA337270
|
Qing
Fang Quan Zheng Sartu District Zi
No.
NA229912
|
Qing
Fang Quan Zheng Sartu
District
Zi
No.
NA221332
|
||||
Owner
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
||||
Location
|
Shangfu
No.4, Building 7, Wanbao No. 2 Community,
Sartu
District
|
No.
44 of
Jing
Qi Street, Dongfeng Xincun, Sartu District
|
No.
44 of
Jing
Qi Street, Sartu District
|
No.5,
6, 7,
Ground
Floor, 3-36A,
Dongfeng
Xincun, Sartu District
|
||||
Category
|
Owned
by Joint Stock Company
|
Owned
by Joint Stock Company
|
Owned
by joint stock company
|
Private
|
||||
Area
(square meters)
|
1,872.62
|
1,500
|
6,674.43
|
137.57
|
||||
Encumbrances
|
Mortgaged
to Daqing Commercial Bank with the guaranty value of RMB 4,369,010 from
December 12, 2008 to November 20, 2010.
|
Mortgaged
to Daqing Commercial Bank with the guaranty value of RMB 4,549,545 from
December 12, 2008 to November 20, 2010
|
Mortgaged
to Daqing Commercial Bank with the guaranty value of RMB 27,600,000 from
June 18, 2009 to June 18, 2011
|
Mortgaged
to Daqing Commercial Bank with the guaranty value of RMB 481,445 from
December 12, 2008 to November 20,
2010
|
Leased
Premises
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year (Yuan)
|
||||
1
|
Daqing
Longfeng Shopping Center Company Limited
|
First
Floor of Longfeng Shopping Center
|
5-1-2000
to
5-1-2010 |
200,000
|
||||
*2
|
Daqing
Hongyun Shopping Center
|
Department
Store of Chengxin En Cum Second Community of Chengxin, Ranghu
Road
|
2-1-2009
to
1-31-2012 |
400,000
|
||||
3
|
Nonggongshang
Branch of Transportation Company
|
Xizhai
Market of Longnan Qiushi Road (2,650m 2 ,
additional 137 m 2
)
|
2003-2-15
to
2011-2-15
|
700,000
for year 1-2; 750,000 for year 3-6; 800,000 for year
7-8.
|
||||
4
|
Hengmao
Company of Daqing Oilfield
|
Cheng
Bei Qi Street, Rang District, Daqing
|
2002-12-15
to
2010-12-15
|
350,000
|
36
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year (Yuan)
|
||||
5
|
Yixi
Huayou Store
|
Operation
Area, warehouse, three rooms for Office, West of Huayou Road, Yixi Xinghua
Street, Longfeng District
|
2003-1-1
to
2013-1-1
|
270,000
|
||||
*6
|
Petro
China Daqing Petro Chemical Company
|
Second
and third Floor of Yixi Huayou Shopping Center (1,620 m 2
)
|
2008-1-1
to
2018-1-1
|
300,000
|
||||
7
|
Yigeng
Property Management Company of Daqing Development Zone
|
Shidai
Lijing Building 107# (135 m 2
)
|
2003-4-20
to
2011-4-20
|
Free
for first 2 years, 30,000 for last 6 years
|
||||
8
|
Zhaodong
Yibai Company Limited
|
South
of Xinjian Yibai Building, Nanerdao Street, East of Zhengyang Street,
Zhaodong
|
2004-1-1
to
2014-1-1
|
300,000
|
||||
9
|
Haibo
Zhao
|
Room
201, 2 nd
Floor, Building 1, Hubin Community, Sartu District
|
2005-1-1
to
2015-1-1
|
20,000
|
||||
10
|
Hui
Hu
|
Room
326, 2 nd
Floor, Building 1, Hubin Community, Sartu District
|
2005-1-1
to
2015-1-1 |
10,000
|
||||
11
|
Yajuan
Wu
|
No.15
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1 |
80,000
|
||||
12
|
Yajuan
Wu
|
No.14
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
13
|
Yingtian
Li
|
No.9
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1 |
80,000
|
||||
14
|
Shuzhi
Liang
|
No.13
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
15
|
Runzhi
Chen
|
No.10
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
16
|
Xiaoguang
Qin
|
No.
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1 |
80,000
|
* No
lease agreement provided.
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year (Yuan)
|
||||
17
|
Qing
Xiao & Hong Xiao
|
No.
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
*18
|
Logistics
Company of Daqing Oilfield
|
N0.7
Qinfen East Road, Sartu District, Daqing
|
2006-1-1
to
2010-12-31
|
252,000/year,
(total fee: 1,260,000)
|
||||
19
|
Daqing
Beichen Real Estate Development Company Limited
|
First
Floor of Lüse Jiayuan Guild Hall, Xuewei Road, Daqing (1,450.22 m 2
)
|
2005-12-1
to
2015-12-1 |
Free
for first to third year and 114,300 for fourth to tenth
year
|
||||
20
|
Yichun
Mengke Shopping Center
|
First
Floor of Basement, Mengke Shopping Center No. 62, Tonghe Road,
Yichun
|
2006-3-5
to
2021-3-5
|
Free
for first year 200,000 for second year, 300,000 for third to fifth year,
400,000 for sixth to tenth year and 500,000 for eleventh to fifteenth
year
|
37
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year (Yuan)
|
||||
21
|
Jixi
Green Sea Consuming Goods Market
|
Ground
Floor, Jixi Green Sea Square
|
2006-6-11
to
2016-6-11
|
700,000
|
||||
22
|
Mengke
Real Estate Development Company Limited
|
Buildings
and facilities at Jiyuan Culture Square, Yanchuan South Street,
ACheng
|
2006-8-20
to
2021-8-20
|
350,000
for first to fifth year, and 400,000 for sixth to tenth year, and
2,100,000 for the remaining years.
|
||||
23
|
Guifen
Zhao
|
Basement
1 of Dongfeng Garden 3, Donfeng Road, Jiguan District, Jixi (2,700 m 2
)
|
2007-1-1
to
2017-1-1 |
600,000
|
||||
24
|
Daqing
Factory for SINOFECT
|
Zone
8, Xinhua Village, Longfeng District (2,800 m 2
)
|
2006-12-14
to
2010-12-13
|
260,000
|
||||
25
|
Heilongjiang
Beidahuang Food and Oil Wholesale Company Limited
|
No.
41 Xiangdian Street, Xiangfang District, Harbin (2,950 m 2
)
|
2006-10-15
to
2016-10-14
|
720,000
for year 1-3, 735,000 for year 4-6, and 750,000 for year
7-10
|
||||
26
|
Qiquan
Zhou
|
Songjiang
Mingzhu Shopping Center, West of Zhongyang St. Zhaoyuan County, Heilong
jiang
|
2008-4-10
to
2018-4-09
|
84,000
for 1 st
to 3 rd
year; 89,375 for 4 th
to 6 th
year; 94,750 for 7 th
to 10 th
year
|
* No
lease agreement provided.
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year
(Yuan)
|
||||
27
|
Suihua
Fudu Construction and Installation Ltd.
|
Zhongxing
East Road, Suihua No. 79-81 Zhongyang Blvd. Ranghu District, Daqing,
China
|
2008-7-1
to
2018-6-30
|
800,000
for 1 st
to 3 rd
years, 850,000 for 4 th
to 6 th
,900,000 for 7 th
to 10 th
years.
|
||||
28
|
Beiya
Construction and Development Ltd. Of Qitaihe
|
Kanghua
St. Boli County, Heilongjiang, China
|
2008-10-30
to
2023-10-30
|
1,100,000
for 1 st
to 5 th
year, 1,200,000for 6 th
to 15 th
year.
|
||||
29
|
Mo
Xu
|
No.
78 Zhongyang Blud. Ranghulu District, Daqing
|
5-20-2008
to
6-20-2016
|
530,000
for 1 st
to 3 rd
year
560,000
for 4 th
to 8 th
year
|
||||
30.
|
Shujun
Wang
|
No.
78 Zhongyang Blvd. Ranghulu District, Daqing
|
5-20-2008
to
6-20-2016
|
530,000
for 1 st
to 3 rd
year
560,000
for 4 th
to 8 th
year
|
||||
31.
|
Lexi
xu
|
No.
78 Zhongyang Blvd. Ranghulu District, Daqing
|
6-20-2008
to
6-20-2016
|
540,000
for 1 st
to 3 rd
year
580,000
for 4 th
to 8 th
year
|
38
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year
(Yuan)
|
||||
32.
|
Yusheng
Cheng
|
No.
78 Zhongyang Blvd.Ranghulu District, Daqing
|
5-20-2008
to
6-20-2016
|
74,000
per year
|
||||
33.
|
Alateng
Shopping Center Co. Ltd.
|
Alateng
Shopping Center
|
9-1-2008
to
8-31-2023
|
700,000
|
||||
34.
|
Zhaodong
Huafu Pharmaceutical Co. Ltd.
|
South
of the Crossing between No. 9 Street and Zhengyang Street,
Zhaodong
|
11-01-2008
to
10-31-2018 |
1,800,000
for 1 st
to 2 nd
year
900,000
since 3 rd
year
|
||||
35.
|
Lin
Dian Lianyi Commerce Co. Ltd.
|
The
crossing between Hexiang Road and Daqi Street, Lidian
county
|
1-1-2009
to
12-31-2024
|
using
area x 0.4/m 2 x
365 for 1 st
to 5 th
year using area x 0.45/m 2 x
365 for 6 th
to 10 th
year using area x 0.5/m 2 x
365 for 11 th
to 15 th
|
||||
36.
|
Daqing
Wanbao Property Management Co. Ltd.
|
Third
Community of Wanbao Zone, Sartu District, Daqing
|
4-10-2003
to
10-4-2013
|
90,000
for 1 st
year
110,000
for 2 nd
year
120,000
for 3 rd
year
150,000
for 4 th
to 10 th
year
|
* No
lease agreement provided.
Item
3. Legal
Proceedings
Neither
we nor any of our subsidiaries is a party to any pending legal
proceedings.
Item
4. (Removed
and Reserved)
39
PART
II
Item
5. Market
for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
Market
Information
On
October 21, 2009, our common stock was listed on NASDAQ under the symbol
“QKLS.” Prior to that date our common stock was traded on the
OTCBB.
The
following table sets forth the high and low bid prices, on the OTCBB, as
reported and summarized by the OTCBB, or NASDAQ, as applicable, for each fiscal
quarter during the fiscal years ended December 31, 2008 and 2009 and for the
first quarter of 2010.
Quarter
Ended
|
High
|
Low
|
||||||
2010:
|
||||||||
First
Quarter (through March 24, 2010)
|
$ | 7.09 | $ | 4.99 | ||||
2009:
|
||||||||
First
Quarter
|
$ | 2.50 | $ | 2.50 | ||||
Second
Quarter
|
5.50 | 2.50 | ||||||
Third
Quarter
|
8.75 | 3.50 | ||||||
Fourth
Quarter
|
7.64 | 5.00 | ||||||
2008:
|
||||||||
First
Quarter
|
$ | 3.00 | $ | 1.25 | ||||
Second
Quarter
|
6.40 | 1.60 | ||||||
Third
Quarter
|
6.50 | 5.50 | ||||||
Fourth
Quarter
|
6.50 | 2.50 |
As of
March 29, 2010, the last reported sale price of our common stock was $6.30 per
share.
As of
March 29, 2010, there were 29,653,431 shares of our common stock and 7,370,898
shares of our Series A Preferred Stock issued and outstanding and we had
approximately 680 shareholders of record of our common stock and five holders of
record of our Series A Preferred Stock. This does not reflect the number of
persons or entities who hold stock in nominee or “street” name through various
brokerage firms.
Dividends
We have
never declared or paid any cash dividends on our common stock and are restricted
from paying dividends by virtue of the fact that we are a holding company. We
currently intend to retain all earnings, if any, for use in business operations
and we do not anticipate declaring any dividends in the near
future.
The
payment of dividends is contingent on the ability of our PRC based operating
subsidiary QKL-China to obtain approval to send monies out of the PRC. The PRC’s
national currency, the Yuan or renminbi, is not a freely convertible currency.
The PRC government imposes controls on the convertibility of renminbi into
foreign currencies and, in certain cases, the remittance of currency out of the
PRC. Shortages in the availability of foreign currency may restrict our ability
to remit sufficient foreign currency to pay dividends.
In
addition, under the terms of Series A Preferred Stock set forth in a Certificate
of Designation which was filed in the office of Secretary of State for the State
of Delaware on March 13, 2008, if we pay dividends on the common stock the
holders of Series A Preferred are entitled to receive dividends on an “as
converted” basis.
40
Securities
authorized for issuance under equity compensation plans
On
September 14, 2009, we adopted the 2009 Omnibus Securities and Incentive Plan
(the “Plan”). The Plan provides for the grant of incentive stock options and
restricted stock awards (the “Awards”). The Plan has not been approved by our
stockholders.
The total
number of shares of common stock that may be issued under the Plan may not
exceed 3,750,000. The total number of shares may be increased annually based
upon the total number of shares of common stock outstanding in subsequent years.
In connection with the private placement we completed in March 2008, we agreed
to limit the number of awards we grant under any stock option, restricted or
other equity incentive plans to no more than 12.5% of the sum of the number of
shares of common stock issued and outstanding and the number of shares of common
stock into which the issued and outstanding shares of Series A Preferred Stock
are convertible at any time.
On
September 14, 2009, the Company issued non-transferable options to three newly
appointed independent directors to purchase an aggregate of 60,000 shares of
common stock at an exercise price of $7.50 per share. The options vest and
become exercisable in three equal amounts on the three subsequent anniversary
dates of the grant. The board of directors approved such grants.
Recent
Sales of Unregistered Securities
None.
Issuer
Purchases of Equity Securities
None.
Use
of Proceeds from Registered Offering
On
November 27, 2009, we consummated a public offering of 6,000,000 shares of
common stock at a public offering price of $5.75 per share. On
December 4, 2009, we consummated a public offering of an additional 900,000
shares of common stock as a result of the exercise of the over-allotment option.
Aggregate gross proceeds were $39,675,000 and we received net proceeds of
approximately $37.4 million from the offering, after deducting underwriting
discounts and estimated offering expenses of $2,275,000.
We
offered the shares sold in the offering pursuant to our registration statement
on Form S-1 (File No. 333-162150), which was declared effective by the SEC on
November 19, 2009. We used approximately $12.8 million of the net proceeds from
the offering to open a new distribution center and new stores, store renovations
and relocations, and the remaining $24.6 million will be used for working
capital and other general corporate purposes, which may include, among other
things, the expansion of our existing capacity and potential
acquisitions.
The
offering was underwritten by Roth Capital Partners, LLC.
Item
6.
|
Selected
Financial Data
|
Pursuant
to Item 301(c) of Regulation S-K (§ 229.301(c)), the Company is not required to
provide the information required by this Item as it is a “smaller reporting
company,” as defined by Rule 229.10(f)(1).
41
Item
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
Throughout
this section, our fiscal years ended December 31, 2009 and December 31,
2008 are referred to as fiscal 2009 and 2008, respectively. The following
management’s discussion and analysis should be read in conjunction with our
financial statements and the notes thereto and the other financial information
appearing elsewhere in this report. In addition to historical information, the
following discussion contains certain forward-looking information. See “Special
Note Regarding Forward Looking Statements” above for certain information
concerning those forward looking statements.
Overview
We are a
regional supermarket chain that currently operates 34 supermarkets and two
department stores in northeastern China and Inner Mongolia. Our supermarkets
sell a broad selection of merchandise including groceries, fresh food and
non-food items. We have two distribution centers servicing our
supermarkets, one for fresh food and one for grocery and non-food
merchandise.
We
believe that we are the first supermarket chain in northeastern China and Inner
Mongolia that is a licensee of the Independent Grocers Alliance, or IGA, a
United States-based global grocery network with aggregate retail sales of more
than $21.0 billion per year. As a licensee of IGA, we are able to engage in
group bargaining with suppliers and have access to more than 2,000 private IGA
brands, including many that are exclusive IGA brands.
Our
expansion strategy emphasizes growth through geographic expansion in
northeastern China and Inner Mongolia, where we believe local populations can
support profitable supermarket operations, and where we believe competition from
large foreign and national supermarket chains, which generally have resources
far greater than ours, is limited. Our strategies for profitable
operations include buy-side initiatives to reduce supply costs; focusing on
merchandise with higher margins, such as foods we prepare ourselves and private
label merchandise; and increasing reliance on the benefits of membership in the
international trade group IGA.
We
completed the initial steps in the execution of our expansion plan in March
2008, when we raised financing through the combination of our reverse merger and
private placement. Under that plan, we opened 7 new stores in 2009 that have, in
the aggregate, approximately 32,000 square meters of space and 10 new stores in
2008 that have, in the aggregate, approximately 42,000 square meters of space. 6
stores opened in 2008 were opened by us and 4 of the new stores were opened
through the acquisition of existing businesses by us. In 2010, we plan to open
additional hypermarkets, supermarkets and department stores having, in the
aggregate, approximately 100,000 square meters of space and one additional
distribution center in the second quarter of 2010 that will have approximately
19,600 square meters of space. We are also making improvements to our logistics
and information systems to support our supermarkets. We expect to finance our
expansion plan from funds generated from operations, bank loans and proceeds
from our fourth quarter 2009 public offering. Our long-term target is to open
more than 200 stores over the next 5 years, including hypermarkets, supermarkets
and department stores.
Our Operations in
China
Our
headquarters and all of our stores are located in the provinces of northeastern
China and Inner Mongolia. The economy of this area has grown rapidly over the
last four to five years and we believe that the national government is committed
to enhancing economic growth in the region. In December 2003, a major
economic-development plan for northeastern China, the “Plan for Revitalizing
Northeast China,” was announced by an office of the national government’s State
Council.
Based on
our own research, we believe there are approximately 200 to 300 small and
medium-sized cities in northeast China without modern supermarket chains. We
believe the number of supermarket customers and the demand for supermarkets in
these cities are likely to grow significantly over the next several years as the
region continues to experience urbanization.
Our Strategy for Growth and
Profitability
Our
strategic plan includes the following principal
components: expanding by opening stores in new strategic locations,
and improving profitability by decreasing the cost through resource purchase,
setting up distribution centers and increasing the percentage of our sales
attributable to private label merchandise, membership sales and buying card
sales.
Expanded
Operations
As of
December 31, 2009, we operated 34 supermarkets, 2 department stores, 2
distribution centers, one for non-fresh merchandise and one for fresh food.
Under our expansion plan, we opened 7 new stores in 2009 that have, in the
aggregate, approximately 32,000 square meters of space. All of these stores
were opened by us. In 2010, we plan to open additional hypermarkets,
supermarkets and department stores having, in the aggregate, approximately
100,000 square meters of retail space. Some of the stores will be opened by
us and others will be opened by acquisition. We are also making improvements to
our logistics and information systems to support our supermarkets. We expect to
finance our expansion plan from funds generated from operations, bank loans and
proceeds from our pending public offering offering. Based on our previous
experience, we believe it takes three to six months for a new store to achieve
profitability.
42
Private Label
Merchandise
Some of
the merchandise we sell is made to our specifications by manufacturers using the
QKL brand name. We refer to such merchandise as “private label”
merchandise. With private label merchandise, we entrust the
manufacturer to make the product and to select the name and
design. Under our agreements with the private label marnufacturer,
the private label manufacturers can not sell the product to any other party.
Sales of private label merchandise accounted for approximately 5% of
our total revenues in 2009 and 2008, respectively. In June 2008, we established
a specialized department for designing and purchasing private label
merchandise. 8 full-time employees currently work in this
department. Our goal is to increase private label sales to 20% of our total
revenues in the near future.
Principal Factors Affecting
Our Results
The
following factors have had, and we expect they will continue to have, a
significant effect on our business, financial condition and results of
operations.
Seasonality – Our
business is subject to seasonality, with increased sales in the first quarter
and fourth quarter, due to increases in shopping and consumer activity as a
result of the holidays such as New Year (January 1), Chinese Lunar New
Year (January or February), the Dragon Festival (February 2), Women’s Day
(March 8), the Back to School Day (March 1), National Day (October
1), Mid-Autumn Festival (September or October) and Christmas (December
25).
Timing of New
Store Openings – Growth through new store openings is a
fundamental part of our strategy. Our new stores typically operate at a
loss for approximately three months due to start-up inventory and other costs,
promotional discounts and other marketing costs and strategies associated with
new store openings, rental expenses and costs related to hiring and training new
employees. Our operating results, and in particular our gross margin,
have and will continue to vary based in part on the pace of our new store
openings.
Locations for
New Store – Good
commercial space that meets our standards, in locations that meet our needs, may
be scarce in some of the cities we wish to enter. One option for
entering certain target markets within our intended timeframe may be to
begin operations in a location that is not optimal and wait for an
opportunity to move to a better location. Alternatively, we may seek to
enter into a target market through acquisitions. As such, the timing and
costs associated with entry into new markets can be difficult to
predict. Identifying and pursuing opportunities will be a
resource-intensive challenge, and if we do not perform or if actual costs of
entering new markets exceed our expectations, our total revenues, cash
flows, and liquidity could suffer.
Logistics of
Geographic
Expansion – Opening
additional stores in cities further from our headquarters in Daqing will mean
that the transportation of our supplies and personnel among our stores will
become more difficult and subject to disruption. To alleviate this, we plan to
expand our distribution capabilities by opening a new distribution center in
Harbin in the 2nd quarter of 2010. We started using our regional purchasing
systems in 2008. All fresh food is ordered by individual stores based on
their needs from local vendors designated by our headquarters or regional
purchasing department and is delivered directly by the local vendors to
individual stores. A portion of our non-perishable food and non-food items are
distributed from our distribution center to our different stores, and the
remaining portion is purchased by our regional purchasing department or
headquarters and delivered directly to individual stores. Long-distance
transportation for both food and non-food items from our distribution center to
our stores can be challenging in the winter as the roads can be covered
with snow. As we expand in territories further from our existing or planned
distribution facilities, the costs of delivering food and merchandise may become
less /predictable and more volatile.
Human
Resources – In
our experience, it takes approximately three months to train new employees to
operate a new store. Training and supervision is organized by experienced
teachers in our training school. The management team for a new store is
hired first and is trained in our training school, where they learn our
culture and operations. Employees are hired afterwards, and are trained by both
our teachers and the management team. In addition, the management team and
the employees are sent to existing stores to get practical training from the
employees and management team members in those stores. Eventually, local
employees must learn to perform the training and supervisory roles themselves.
If we do not perform well in response to these challenges, our operating costs
will rise and our margins will fall.
43
Shortages of
Trained
Staff in
Our New Locations – Opening
stores in locations with little or no competition from other large supermarkets
is a major part of our strategy. However, there are disadvantages to this
approach, which relate to human resources. Where competitors operate
supermarkets nearby, their trained staff is a potential source for our own human
resources needs, especially if we offer a superior compensation package. Cities
that have no large supermarkets also have no sources of trained employees.
Although we believe we have a good training school, from time to time we have to
send experienced management team members from our headquarters or other stores
to new stores to provide assistance. This increases our cost of operating and
decreases our gross margin.
Critical
Accounting Policies and Estimates
Our
critical accounting estimates are included in our significant accounting
policies as described in Note 2 of the consolidated financial statements
included in Item 8, Financial Statements, of this Annual Report on
Form 10-K. Those consolidated financial statements were prepared in
accordance with GAAP. Critical accounting estimates are those that we believe
are most important to the portrayal of our financial condition and results of
operations. The preparation of our consolidated financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expense. Our estimates are evaluated on an ongoing
basis and drawn from historical experience, current trends and other factors
that management believes to be relevant at the time our consolidated financial
statements are prepared. Actual results may differ from our estimates.
Management believes that the following accounting estimates reflect the more
significant judgments and estimates we use in preparing our consolidated
financial statements.
Revenue
Recognition
We earn
revenue by selling merchandise primarily through our retail stores. Revenue is
recognized when merchandise is purchased by and delivered to the customer and is
shown net of estimated returns during the relevant period. The allowance for
sales returns is estimated based upon historical experience.
Cash
received from the sale of cash card (aka “gift card”) is recorded as a
liability, and revenue is recognized upon the redemption of the cash card or
when it is determined that the likelihood of redemption is remote (“cash card
breakage”) and no liability to relevant jurisdictions exists. We determine the
cash card breakage rate based upon historical redemption patterns and recognizes
cash card breakage on a straight-line basis over the estimated cash card
redemption period. We recognized approximately nil in cash card
breakage revenue for fiscal 2009 and 2008, respectively.
We record
sales tax collected from our customers on a net basis, and therefore excludes it
from revenue as defined in ASC 605, Revenue Recognition.
Included
in revenue are sales of returned merchandise to vendors specializing in the
resale of defective or used products, which accounted for less than 0.5% of net
sales in each of the periods reported.
Inventories
Inventories
primarily consist of merchandise inventories and are stated at lower of cost or
market and net realizable value. Cost of inventories is calculated on the
weighted average basis which approximates cost.
Management
regularly reviews inventories and records valuation reserves for damaged and
defective returns, inventories with slow-moving or obsolescence exposure and
inventories with carrying value that exceeds market value. Because of its
product mix, we have not historically experienced significant occurrences of
obsolescence.
Inventory
shrinkage is accrued as a percentage of revenues based on historical inventory
shrinkage trends. The Company performs physical inventory counts of its stores
once per quarter and cycle counts inventories at its distribution center once
per quarter. The reserve for inventory shrinkage represents an estimate for
inventory shrinkage for each store since the last physical inventory date
through the reporting date.
These
reserves are estimates, which could vary significantly, either favorably or
unfavorably, from actual results if future economic conditions, consumer demand
and competitive environments differ from expectations.
Long-lived
Assets
We review
long-lived assets for impairment annually or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.
Long-lived
assets are reviewed for recoverability at the lowest level in which there are
identifiable cash flows, usually at the store level. The carrying amount of a
long-lived asset is not considered recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use of the asset. If the
asset is determined not to be recoverable, it is considered to be impaired and
the impairment to be recognized is the amount by which the carrying amount of
the asset exceeds the fair value of the asset, determined using discounted cash
flow valuation techniques, as defined in ASC 360, Property, Plant, and
Equipment.
44
We
determined the sum of the undiscounted cash flows expected to result from the
use of the asset by projecting future revenue and operating expense for each
store under consideration for impairment. The estimates of future cash flows
involve management judgment and are based upon assumptions about expected future
operating performance. The actual cash flows could differ from management’s
estimates due to changes in business conditions, operating performance and
economic conditions.
Our
evaluation resulted in no long-lived asset impairment charges during fiscal 2009
and 2008.
Recently Issued Accounting
Guidance
See
Note 2 to consolidated financial statements included in Item 8,
Financial Statements, of this Annual Report on Form 10-K.
Results
of Operations
The
following table sets forth selected items from our consolidated statements
of operations by dollar and as a percentage of our net sales for the
periods indicated:
Year
Ended
December
31, 2009
|
Year
Ended
December
31, 2008
|
|||||||||||||||
Amount
|
%
of
Net
Sales
|
Amount
|
%
of
Net
Sales
|
|||||||||||||
Net
sales
|
$ | 247,594,272 | 100.0 | % | $ | 160,129,600 | 100.0 | % | ||||||||
Cost
of sales (1)
|
206,639,561 | 83.4 | 129,739,748 | 81.0 | ||||||||||||
Gross
profit
|
40,954,711 | 16.6 | 30,389,852 | 19.0 | ||||||||||||
Selling
expenses (2)
|
21,680,096 | 8.8 | 12,639,565 | 7.9 | ||||||||||||
General
and administrative expenses
|
4,802,262 | 1.9 | 3,249,506 | 2.0 | ||||||||||||
Operating
income
|
14,472,353 | 5.8 | 14,500,781 | 9.1 | ||||||||||||
Other
expenses
|
14,253 | 0.0 | 1,979,460 | 1.2 | ||||||||||||
Changes in fair value of warrants | 35,492,017 | 14.3 | 0.0 | |||||||||||||
Interest
income
|
(222,007 | ) | (0.1 | ) | (272,551 | ) | 0.2- | |||||||||
Interest
expenses
|
23,734 | - | 240,330 | 0.2 | ||||||||||||
Income
(loss) before income taxes
|
(20,835,644 | ) | (8.47 | ) | 12,553,542 | 7.8 | ||||||||||
Income
taxes
|
3,807,794 | 1.5 | 3,556,474 | 2.2 | ||||||||||||
|
||||||||||||||||
Net
income (loss)
|
$ | (24,643,438 | ) | (10.0 | %) | $ | 8,997,068 | 5.6 | % |
Net Sales
– Net sales increased by $87.5 million, or 54.6%, to $247.6 million for 2009
from $160.1 million for 2008. The change in net sales was primarily
attributable to the following:
·
|
Comparable
stores are stores that were opened for at least one year before the
beginning of the comparison period, or by January 1, 2008. Those 18 stores
generated approximately $134.5 million sales in 2009, an increase of $7.5
million, or 5.9% compared with $127.0 million sales in
2008.
|
·
|
New
store sales increased, reflecting the net opening of 16 new stores since
January 1, 2008.
|
·
|
Store
including supermarket/hypermarket and department store at the end of 2009
was 36 versus 30 at the end of fiscal 2008, there were two department
stores at the end of 2009 and 2008. We opened 6 new stores in fiscal 2009,
and opened 10 new stores, net of closures and relocations, in fiscal 2009
and 2008. Our fiscal 2009 store growth was slowed substantially in
response to management strategy of building distribution center, setting
up logistic systems and training systems to get ready for opening more new
stores in the future. We anticipate opening total area of 100,000 square
meters of new stores in year
2010.
|
45
Cost of Sales
– Our
cost of sales for 2008 was approximately $206.6 million, representing an
increase of $76.9 million, or 59.3%, from approximately $129.7 million for 2008.
The increase was due to increase volume of sales. Our cost of sales primarily of
the cost for our merchandises, it also includes related costs of packaging
and shipping costs and the distribution center cost.
We
anticipate that our cost of sales will continue to increase along with our
expansion in the coming quarters.
Gross
Profit – Gross profit, or total revenue minus cost of sales,
was decreased by $10.6 million, or 34.8%, to $41.0 million, or 16.5% of net
sales, in 2009 from $30.4 million, or 19.0% of net sales, in fiscal 2008. The
change in gross profit was primarily attributable to the following:
·
|
Net
sales increased by $ 87.5 million in 2009 compared to
2008.
|
·
|
We
reclassified: 1) distribution cost from selling expenses to cost of sales;
2) rental income from renting spaces in our supermarkets from revenue to
directly offsetting rental income with rental expense; 3) marketing income
from revenue to directly offsetting it with promoting expenses.
The consolidated financial statements and the relevant notes for the prior
years have been changed in conformity with the current year presentation
of the consolidated financial statements and the corresponding notes. For
comparative purposes, the Company reclassified the following: 1)
Approximately $1.4 million of revenue to general and administrative
expenses in the statements of income in year 2008. These selling revenue
were primarily related to sub-lease rental income; 2). Approximately $2.6
million of selling expenses to cost of sales in the statements of income
in year 2008. These selling expenses consisted of distribution costs. We
believes that such reclassification represents better presentation to its
retail industry standard.
|
All of
the reasons above attributed to the gross margin changes. We believe that our
gross margin is likely to be between 17.0% and 19.0%, over the next few business
quarters. New stores tend to be less profitable during their early months
of operation. In addition, China’s retail industry in general, and its
supermarket industry in particular, are becoming more competitive every year. In
this competitive marketplace, it is likely that we will focus on providing our
customers with low prices in order to increase our market share and long-term
sales volume.
Selling
Expenses – Selling expenses increased by $9.0 million, or
71.5%, to $21.7 million, or 8.8% of net sales, in fiscal 2009 from $12.6
million, or 7.9% of net sales, in fiscal 2008. The change in selling expense was
primarily attributable to the increase of labor cost by 5.1million, or 177.1%
compared with fiscal 2008 the increase of labor cost was mainly due to new store
openings and more staff being recruited to meet our growing business in 2009.
Depreciation, rent expense and utilities and other operating costs for fiscal
2009 increased primarily as a result to support the increase in store
count.
General
and
Administrative Expense – General and administrative expenses
increased by $1.6 million to $4.8 million, or 1.9% of net sales, in fiscal
2009 from $3.2 million, or 2.0% of net sales, in fiscal 2008. The change in
general and administrative expenses was primarily attributable to the
increase of labor cost by $2.1million, or 280%.The increase of labor cost was
mainly due to more staff being recruited in our headquarter to meet our growing
business in 2009 and the employee benefits incurred.
Changes in fair value of warrants
– In 2009 we incurred a non-cash charge of $35.5 million unrelated to the
company’s operations, which resulted from the change in fair value of warrants
issued to investors in conjunction with the Company’s issuance of warrants in
March 2008 pursuant to provisions of FAB ASC Topic 815, “Derivative and Hedging”
(“ASC 815”). The accounting treatment of the warrants resulted from a provision
providing anti-dilution protection to the warrant holders. The warrant holders
have permanently waived the “down-round” protection from the warrants as of
March 30, 2010. Therefore, we believe that the non-cash charges affecting net
income will not be applied after December 31, 2009. See Note 16 “Subsequent
Events”.
Income
Taxes – The provision for income taxes was $3.8 million for fiscal
2009 compared with $ 3.6 million for fiscal 2008. This increase was
primarily due to higher pre-tax income (excluding changes in fair value of
warrants) in fiscal 2009 compared to the prior year. Our effective tax rate was
negative 18.3% for fiscal 2009 compared with 28.3% for fiscal
2008.
Net
Income
For
fiscal 2009 we had a net loss of $24.6 million, compared to net income of $9.0
million in fiscal 2008. In 2009 our net loss was impacted by a
non-cash charge of $35.5 million unrelated to the company’s
operations. Excluding this $35.5 million non-cash charge, the Company’s net
income from operations for the full year 2009 would have been $10.8 million,
representing a year over year net income growth of 20.6%.
Liquidity
and Capital Resources
Our
principal liquidity requirements are for working capital, capital expenditures
and cash dividends. We fund our liquidity requirements primarily through cash on
hand, cash flow from operations and borrowings from our revolving credit
facility. We believe our cash on hand, future funds from operations and
borrowings from our revolving credit facility will be sufficient to fund our
cash requirements for at least the next twelve months. There is no assurance,
however, that we will be able to generate sufficient cash flow or that we will
be able to maintain our ability to borrow under our revolving credit
facility.
We ended
fiscal 2009 with $45.9 million of cash and cash equivalents compared to $19.3
million in fiscal 2008. We reduced our short-term debt by $2.2 million during
fiscal 2009 to nil from $2.2 million at the end of fiscal 2008. The following
table sets forth a summary of our cash flows for the periods
indicated:
Years
Ended December 31,
|
2009
|
2008
|
|||||
Net
cash provided by operating activities
|
$
|
10,866,330
|
$
|
18,661,267
|
|||
Net
cash used in investing activities
|
(19,455,014
|
)
|
(24,528,810
|
)
|
|||
Net
cash provided by financing activities
|
35,210,517
|
12,627,365
|
|||||
Effect
of foreign currency translation
|
5,944
|
1,783,135
|
|||||
Net
change in cash
|
$
|
26,627,777
|
$
|
8,542,957
|
46
The
seasonality of our business historically provides greater cash flow from
operations during the holiday and winter selling season, with the fourth fiscal
quarter net sales traditionally generating the strongest profits of our fiscal
year. Typically, we use operating cash flow and borrowings under our revolving
credit facility to fund inventory increases in anticipation of the holidays and
our inventory levels are at their highest in the months leading up to Chinese
Spring Festival. As holiday sales significantly reduce inventory levels, this
reduction, combined with net income, historically provides us with strong cash
flow from operations at the end of our fiscal year.
Our
improved earnings contributed to higher cash flow from operations for fiscal
2009 compared to fiscal 2008, which enabled us to continue to increase our work
in capital and to decrease our bank loans. In 2009 we purchased larger
quantities of inventory earlier in the year to insure adequate product
availability for the holiday and winter selling season. The higher inventory
levels and timing of purchases combined with lower than anticipated sales in the
fourth quarter of fiscal 2009 resulted in reduced operating cash flow for the
year.
Operating
Activities – Net cash provided by operating activities for fiscal 2009
and 2008 was $10.9 million and $18.7 million, respectively. The
decrease in cash provided by operating activities for fiscal 2009 compared to
fiscal 2008 primarily reflects net loss offset by change in fair value of
warrants for the year, higher other receivables resulted from lending money to
vendors in the amount $7.3 million to help insure adequate levels of merchandise
during the peak Chinese new year season and increases in accrued expenses
and higher inventory levels.
Investing
Activities – Net cash used in investing activities for fiscal 2009 and
2008 was $19.5 million and $24.5 million, respectively. Capital
expenditures represented substantially all of the net cash used in
investing activities for each period. Capital expenditures were lower in fiscal
2009 due to substantially fewer new store openings. Our capital spending is
primarily for new store openings, store-related remodeling and distribution
center and corporate headquarters. Capital expenditures by category for each of
the last two fiscal years are as follows:
Years
Ended December 31,
|
2009
|
2008
|
|||||
New
stores
|
$
|
8,553,096
|
$
|
4,475,383
|
|||
Acquisition
of stores
|
-
|
19,640,200
|
|||||
New
distribution center
|
11,647
|
120,078
|
|||||
Pledged
deposits
|
(111,313
|
) |
293,149
|
||||
New
headquarter
|
11,001,584
|
-
|
|||||
Total
|
$
|
19,455,014
|
$
|
24,528,810
|
Capital
spending in fiscal 2009 was lower than prior year as we opened fewer stores in
2009 than in 2008 and six of the seven stores were opened by ourselves in 2009,
whereas five stores were opened by acquisition in fiscal 2008. Our capital
expenditures for new stores included 6 new stores in fiscal 2009 and 10 new
stores, net of closures and relocations, in fiscal 2008. Capital expenditures in
fiscal 2009 included amounts related to purchase office buildings of
RMB75million (amount to approximately $11million).
Financing
Activities – Net cash proceeds from financing activities for fiscal 2009
and 2008 was $35.2 million and $12.6 million, respectively. In the
fourth quarter of 2009 we raised an aggregate of $39.7 million in a public
offering of 6,900,000 shares of our common stock at a price of
$4.75. For fiscal 2009 and 2008, cash provided by financing
activities was used to open new stores, and a distribution center, store
renovations and relocations.
As of
December 31, 2009, we had not revolving credit borrowings, we had a credit
line up to RMB27.6 million (amount to $4.0 million ) under our
financing agreement. These balances compare to borrowings of
$2.2 million and letter of credit commitments of RMB 5 million (amount
to $0.7million) outstanding under our financing agreement as of
December 31, 2008.
Financing
Agreement – On
June 18, 2009 , we entered into a financing agreement with Daqing City
Commercial Bank, under this agreement, the Company had a credit line up to
RMB27.6 million(amount to $4.0million ) from June 18,2009 to June
18,2011. The loan under this financing agreement will be secured by
buildings with net work book value of RMB37.4million (amount to approximately
$5.5million).
Future Capital
Requirements – We had cash on hand of $45.9 million at
December 31, 2009. We expect capital expenditures for fiscal 2010primarily
to fund the opening of new stores, store-related remodeling and relocation,
distribution center equipment and computer hardware and software purchases. We
anticipate opening 100,000 square meters of new stores in fiscal 2010
compared to 32,000 square meters of new stores in fiscal
2009.
We
believe we will be able to fund our cash requirements, for at least the next
twelve months, from cash on hand, operating cash flows and borrowings from our
revolving credit facility. However, our ability to satisfy our cash requirements
depends upon our future performance, which in turn is subject to general
economic conditions and regional risks, and to financial, business and other
factors affecting our operations, including factors beyond our control. There is
no assurance that we will be able to generate sufficient cash flow or that we
will be able to maintain our ability to borrow under our revolving credit
facility.
47
If we are
unable to generate sufficient cash flow from operations to meet our obligations
and commitments, or if we are unable to maintain our ability to borrow
sufficient amounts under our existing revolving credit facility, or successfully
negotiate and enter into a new revolving credit facility to replace our current
facility, which has an initial termination date of June 18, 2011, we will
be required to refinance or restructure our indebtedness or raise additional
debt or equity capital. Additionally, we may be required to sell material assets
or operations, suspend or further reduce dividend payments or delay or forego
expansion opportunities. We might not be able to implement successful
alternative strategies on satisfactory terms, if at all.
Off-Balance Sheet
Arrangements and Contractual Obligations – Our material off-balance sheet
arrangements are operating lease obligations. We excluded these items from the
balance sheet in accordance with generally accepted accounting principles in the
United States of America (“GAAP”). Information regarding our operating leases is
available in Item 2, Properties and Note 12,
Lease Commitments, of
the notes to consolidated financial statements included in Item 8, Financial Statements and
Supplementary Data, of this Annual Report on
Form 10-K.
Operating
lease commitments consist principally of leases for our retail store facilities
and distribution center. These leases frequently include options which permit us
to extend the terms beyond the initial fixed lease term. With respect to most of
those leases, we intend to renegotiate those leases as they
expire.
In the
ordinary course of business, we enter into arrangements with vendors to purchase
merchandise in advance of expected delivery. Because most of these purchase
orders do not contain any termination payments or other penalties if cancelled,
they are not included as outstanding contractual obligations.
Item
7A.
|
Quantitative
and Qualitative Disclosures about Market
Risk
|
Pursuant
to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to
provide the information required by this Item as it is a “smaller reporting
company,” as defined by Rule 229.10(f)(1).
48
Item
8.
|
Financial
Statements and Supplementary Data
|
The
financial statements and supplementary data required by this item are included
in a separate section of this Report. See “Index to Consolidated Financial
Statements” on Page F-1.
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
On October 15, 2009, we dismissed
Albert Wong & Co. (“Albert Wong”), as our independent registered public
accounting firm. The reports of Albert Wong on our financial statements for each
of the past two fiscal years contained no adverse opinion or a disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principles. The decision to change independent accountants was
approved by our Audit Committee on October 14, 2009.
During
our two most recent fiscal years and through October 16, 2009, the date of
filing our Current Report on Form 8-K announcing the dismissal of Albert Wong,
we have had no disagreements with Albert Wong on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of Albert
Wong, would have caused it to make reference to the subject matter of such
disagreements in its report on our financial statements for such
periods.
During
our two most recent fiscal years there have been no reportable events as defined
under Item 304(a)(1)(v) of Regulation S-K adopted by the SEC.
Albert
Wong has provided us with a letter addressed to the SEC stating that it agreed
with the above statements. This letter was filed as an exhibit to our Current
Report on Form 8-K, which was filed with the SEC on October 16,
2009.
On October 16, 2009, we appointed BDO
China Li Xin Da Hua CPA Co., Ltd. (formerly known as BDO Guangdong Dahua Delu
CPAs, LLP) (“BDO”) as our new independent registered accounting firm. The
appointment of BDO was approved by our Audit Committee on October 14,
2009.
Item
9A.
|
Controls
and Procedures
|
Disclosure Controls and
Procedures.
As
required by Rule 13a-15 under the Exchange Act, in connection with filing of
this Annual Report on Form 10-K, our management, including our chief executive
officer and chief financial officer, evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2009 and has
determined that our disclosure controls and procedures were not
effective. This conclusion was based on the fact that on December 30,
2009, we entered into an agreement to acquire a building for use as our new
headquarters. Pursuant to Item 1.01 of Form 8-K under the Exchange
Act, we should have filed a current report on Form 8-K disclosing the agreement
by January 6, 2010, but we did not file such current report until January 25,
2010.
Management’s Report on
Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the
process designed by, or under the supervision of, our principal executive
officer and principal financial officer, and effected by our Board of Directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles, and includes those policies and procedures that:
(1)
Pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our assets;
(2)
Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorization of our management and directors;
and
49
(3)
Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisitions, use or disposition of our assets that could have a
material effect on the financial statements.
Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal
control over financial reporting is a process that involves human diligence and
compliance and is subject to lapses in judgment and breakdowns resulting from
human failures. Internal control over financial reporting also can be
circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented or
detected on a timely basis by internal control over financial reporting.
However, these inherent limitations are known features of the financial
reporting process. Therefore, it is possible to design into the process
safeguards to reduce, though not eliminate, this risk. Management is responsible
for establishing and maintaining adequate internal control over financial
reporting for the company.
Management
has used the framework set forth in the report entitled Internal
Control—Integrated Framework published by the Committee of Sponsoring
Organizations of the Treadway Commission, known as COSO, to evaluate the
effectiveness of our internal control over financial reporting. Based on this
assessment, management has concluded that our internal control over financial
reporting was not effective as of December 31, 2009.
The
conclusion that our internal control over financial reporting was not
effective was based on material weaknesses we identified in relation to our
financial closing process and assessment of critical accounting areas relating
to recognition of warrants.
In
connection with the preparation and audit of our 2009 financial statements and
notes, we were informed by our auditor, BDO China Li Xin Da Hua CPA co. Ltd.
(“BDO”) of certain deficiencies in our internal controls that BDO considered to
be material weaknesses. These deficiencies related to our financial closing
procedures and errors in classification of warrants. After
discussions between management, our audit committee and BDO, we concluded that
the Company had improperly classified warrants pursuant to FASB ASC Topic 815
“Derivatives and Hedging”) (“ASC 815”). As a result of the
reclassification and the change in the fair value of these warrants, the Company
recognized a $35.5 million net loss for the year ended December 31,
2009.
In
addition, as a result of the reclassification, on March 31, 2009 our audit
committee met with BDO and made a determination that the Company’s financial
statements in each of its quarterly reports filed in 2009 could not be relied on
that it will restate the Company’s financial statement for each of the quarterly
reports it filed in 2009. The Company filed a current
Report on Form 8-K disclosing these determinations under Item 4.02 of Form 8-K
concurrent with the filing of this Annual report.
Management
intends to continue to implement procedures to remedy such material
weaknesses,
including the possible hiring of additional staff with appropriate
experience.
This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting. Our
management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only our management’s report in this annual
report.
Changes in Internal Control over
Financial Reporting. There were no changes in our
internal control over financial reporting that occurred during the fourth
quarter of 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item
9B.
|
Other
Information
|
None.
50
PART
III
Item
10.
|
Directors
, Executive Officers and Corporate
Governance
|
The information required by this item
is included under the captions “Election of Directors — Compensation of
Non-Employee Directors,” “Election of Directors — Compensation Committee
Interlocks and Insider Participation,” “Compensation Discussion and Analysis,”
and “Compensation Committee Report” in the 2010 Proxy Statement and incorporated
herein by reference.
Item
11.
|
Executive
Compensation
|
The information required by this item
is included under the captions “Equity Compensation” in the 2010 Proxy Statement
and incorporated herein by reference.
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
The information required by this item
is included under the captions “Security Ownership of Certain Beneficial Owners
and Management” and “Equity Compensation Plan Information” in the 2010 Proxy
Statement and incorporated herein by reference.
Item
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
The information required by this item
is included under the captions “Certain Relationships and Related Person
Transactions” and “Election of Directors — Board Meetings and Committees”
in the 2010 Proxy Statement and incorporated herein by reference.
Item
14.
|
Principal
Accounting Fees and Services
|
The information required by this item
is included under the caption “Audit Committee Report” in the 2010 Proxy
Statement and incorporated herein by reference.
51
PART
IV
Item
15.
|
Exhibits,
Financial Statement Schedules
|
(a) The
following documents are filed as part of this Report:
1.
|
Financial
Statements.
|
Incorporated
by reference from the financial statements and notes thereto that are included
in a separate section of this Report. See “Index to Consolidated Financial
Statements” on Page F-1.
2.
|
Financial
Statement Schedules.
|
Except
for “Schedule II - Valuation and Qualifying Accounts,” no schedules have
been filed because they are not applicable or not required, or the information
is included in the Consolidated Financial Statements or Notes
thereto.
(b)
|
Exhibits.
|
The
exhibits listed on the accompanying index to exhibits immediately following the
financial statements are filed as part of, or hereby incorporated by reference
into, this Report.
52
QKL STORES
INC.
INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS
CONTENTS
|
PAGES
|
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
F-1
- F2
|
|
CONSOLIDATED
BALANCE SHEETS
|
F-3
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
F-4
|
|
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
|
F-5
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
F-6
|
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
F-7
– 32
|
|
CONSOLIDATED
FINANCIAL STATEMENT SCHEDULE:
|
SCHEDULE
|
|
VALUATION
AND QUALIFYING ACCOUNTS
|
II
|
53
Report of
Independent Registered Public Accounting Firm
To the
Shareholders and Board of Directors of
QKL
Stores Inc. and Subsidiary:
We have
audited the accompanying consolidated balance sheet of QKL Stores Inc. and
Subsidiary (the “Company”) as of December 31, 2009 and the related consolidated
statements of operations, shareholders’ equity, and cash flows for the year
ended December 31, 2009. In
connection with our audit of the financial statements, we have also audited the
financial statement schedule listed in the accompanying index as of and for the
year ended December 31, 2009. These
financial statements and schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of
QKL Stores Inc. and Subsidiary as of December 31, 2008 and for year ended
December 31, 2008 were audited by other auditors whose report dated March 23,
2009, expressed an unqualified opinion on those statements.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company at December 31,
2009, and the results of its operations and its cash flows for the year ended
December 31, 2008, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 10 to the financial statements, the Company
adopted ASC Topic 815-40, “Derivatives and Hedging: Contracts in Entity’s Own Equity”
(effective January 1, 2009) as it related to the Company’s warrants.
Also, in
our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
BDO China
Li Xin Da Hua CPA Co., Ltd.
Shenzhen,
People’s Republic of China
April 1,
2010
F-1
ALBERT
WONG & CO.
CERTIFIED
PUBLIC ACCOUNTANTS
7th
Floor, Nan Dao Commercial Building
359-361
Queen’s Road Central
Hong
Kong
Tel
: 2851 7954
Fax:
2545 4086
ALBERT WONG
B.Soc.,
Sc., ACA., LL.B.,
CPA(Practising)
|
To: The
board of directors and stockholders of
QKL
Stores Inc. (“the Company”)
Report of Independent
Registered Public Accounting Firm
We have
audited the accompanying consolidated balance sheet of QKL Stores Inc. and
subsidiaries as of December 31, 2008 and the related consolidated statements of
income, stockholders' equity and cash flow for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We
conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of QKL Stores Inc.
as of December 31, 2008 and the results of its operations and its cash flow for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
Hong Kong, China | Albert Wong & Co. |
March 23, 2009 | Certified Public Accountants |
F-2
Item
1. Consolidated Financial Statements
QKL
STORES INC. AND SUBSIDIARIES
Consolidated
Balance Sheets
December
31, 2009
|
December
31, 2008
|
|||||||
ASSETS
|
||||||||
Cash
|
$
|
45,912,798
|
$
|
19,285,021
|
||||
Pledged
deposits
|
181,836
|
293,149
|
||||||
Accounts
receivable, net of allowance for doubtful accounts of nil and nil,
respectively
|
283,929
|
793,352
|
||||||
Inventories
|
24,691,156
|
14,544,341
|
||||||
Other
receivables
|
13,980,572
|
4,189,140
|
||||||
Prepaid
expenses
|
2,993,191
|
1,862,591
|
||||||
Advances
to suppliers
|
2,965,139
|
3,342,756
|
||||||
Deferred
income tax assets
|
417,788
|
-
|
||||||
Total
current assets
|
91,426,409
|
44,310,350
|
||||||
Property,
plant equipment, net
|
29,402,630
|
12,960,303
|
||||||
Land
use rights, net
|
753,226
|
776,259
|
||||||
Goodwill
|
19,280,509
|
18,878,823
|
||||||
Other
assets
|
408,391
|
787,741
|
||||||
Total
assets
|
$
|
141,271,165
|
$
|
77,713,476
|
||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Short-term
bank loans
|
$
|
-
|
$
|
2,188,439
|
||||
Accounts
payable
|
29,244,923
|
21,283,818
|
||||||
Cash
card and coupon liabilities
|
7,721,630
|
3,858,514
|
||||||
Customer
deposits received
|
3,862,890
|
2,901,205
|
||||||
Accrued
expenses and other payables
|
6,656,089
|
2,362,077
|
||||||
Income
taxes payable
|
1,154,229
|
1,252,336
|
||||||
Total
current liabilities
|
48,639,761
|
33,846,389
|
||||||
Warrant liabilities | 44,304,034 |
-
|
||||||
Total liabilities |
92,943,795
|
33,846,389 | ||||||
Commitments
and contingencies
|
-
|
-
|
||||||
Stockholders’
equity
|
||||||||
Common
stock, $.001 par value per share, authorized 100,000,000, shares, issued
and outstanding 29,475,983 and 20,882,353 at December 31, 2009 and
December 31, 2008, respectively
|
29,476
|
20,882
|
||||||
Series
A convertible preferred stock, par value $0.01, 10,000,000 shares
authorized, 7,548,346 and 9,117,647 shares outstanding at
December 31, 2009 and 2008, respectively
|
75,483
|
91,176
|
||||||
Additional
paid-in capital
|
53,191,217
|
21,783,477
|
||||||
Retained
earnings – appropriated
|
4,913,072
|
3,908,247
|
||||||
Retained
earnings (accumulated deficit)
|
(14,236,111
|
) |
14,204,169
|
|||||
Accumulated
other comprehensive income
|
4,354,233
|
3,859,136
|
||||||
Total
stockholders’ equity
|
48,327,370
|
43,867,087
|
||||||
Total
liabilities and stockholders’ equity
|
$
|
141,271,165
|
$
|
77,713,476
|
See
notes to audited consolidated financial statements.
QKL
STORES INC. AND SUBSIDIARIES
Consolidated
Statements of Operations
Years
Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Net
sales
|
$ | 247,594,272 | $ | 160,129,600 | ||||
Cost
of sales
|
206,639,561 | 129,739,748 | ||||||
Gross
profit
|
40,954,711 | 30,389,852 | ||||||
Selling
expenses
|
21,680,096 | 12,639,565 | ||||||
General
and administrative expenses
|
4,802,262 | 3,249,506 | ||||||
Income
from operations
|
14,472,353 | 14,500,781 | ||||||
Other
expenses
|
14,253 | 1,979,460 | ||||||
Changes in fair value of warrants | 35,492,017 | - | ||||||
Interest
income
|
(222,007 | ) | (272,551 | ) | ||||
Interest
expense
|
23,734 | 240,330 | ||||||
Income
(loss) before income tax
|
(20,835,644 | ) | 12,553,542 | |||||
Income
tax expense
|
3,807,794 | 3,556,474 | ||||||
Net
income (loss)
|
$ | (24,643,438 | ) | $ | 8,997,068 | |||
Weighted
average number of shares outstanding
|
||||||||
Basic
|
21,885,423 | 20,882,353 | ||||||
Diluted
|
31,922,995 | 31,137,642 | ||||||
Earnings
(loss) per share
|
||||||||
Basic
|
$ | (1.13 | ) | $ | 0.43 | |||
Diluted
|
$ | (0.77 | ) | $ | 0.29 |
See
notes to audited consolidated financial statements.
F-4
Consolidated
Statements of Shareholders’ Equity
Common
stock
|
Series
A convertible preferred stock
|
Additional
paid-in capital
|
Retained
Earnings - Appropriated
|
Accumulated
deficit
Retained earnings
|
Accumulated
other comprehensive income
|
|||||||||||||||||||||||||||||||
Share
|
Amount
|
Share
|
Amount
|
Total
|
||||||||||||||||||||||||||||||||
January
1, 2008
|
19,082,299 | $ | 19,082 | - | $ | - | $ | 4,457,653 | $ | 2,703,742 | $ | 9,179,694 | $ | 1,424,772 | $ | 17,784,943 | ||||||||||||||||||||
Net
income
|
- | - | - | - | - | - | 8,997,068 | - | 8,997,068 | |||||||||||||||||||||||||||
Reverse
acquisition
|
1,500,055 | 1,500 | - | - | - | - | (851,088 | ) | - | (849,588 | ) | |||||||||||||||||||||||||
Appropriations
to statutory reserves
|
- | - | - | - | - | 1,204,505 | (1,204,505 | ) | - | - | ||||||||||||||||||||||||||
Shares
issued for services
|
299,999 | 300 | - | - | - | - | - | - | 300 | |||||||||||||||||||||||||||
Issuance
of Series A convertible preferred stock
|
- | - | 9,117,647 | 91,176 | 17,325,824 | - | (1,917,000 | ) | - | 15,500,000 | ||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | - | 2,434,364 | 2,434,364 | |||||||||||||||||||||||||||
December
31, 2008
|
20,882,353 | $ | 20,882 | 9,117,647 | $ | 91,176 | $ | 21,783,477 | $ | 3,908,247 | $ | 14,204,169 | $ | 3,859,136 | $ | 43,867,087 | ||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (24,643,438 | ) | - | (24,643,438 | ) | |||||||||||||||||||||||||
Reclassification of warrants from equity to derivative liabilities | (6,020,000 | ) | (2,792,017 | ) | (8,812,017 | ) | ||||||||||||||||||||||||||||||
Compensation
expense for stock option granted
|
- | - | - | - | 14,252 | - | - | - | 14,252 | |||||||||||||||||||||||||||
Warrants
exercised (cashless)
|
124,329 | 124 | (124 | ) | - | - | ||||||||||||||||||||||||||||||
Preferred
stock convert to common stock
|
1,569,301 | 1,570 | (1,569,301 | ) |
(15,693
|
) | 14,123 | - | - | - | - | |||||||||||||||||||||||||
common
shares offering
|
6,900,000 | 6,900 | 37,399,489 | 37,406,389 | ||||||||||||||||||||||||||||||||
Appropriation
to statutory reserves
|
- | - | - | - | - | 1,004,825 | (1,004,825 | ) | - | - | ||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | - | 495,097 | 495,097 | |||||||||||||||||||||||||||
December 31,
2009
|
29,475,983 | $ | 29,476 | 7,548,346 | $ | 75,483 | $ | 53,191,217 | $ | 4,913,072 | $ | (14,236,111 | ) | $ | 4,354,233 | $ | 48,327,370 |
See notes to audited consolidated
financial statements.
F-5
QKL
STORES INC. AND SUBSIDIARIES
Consolidated
Statements of Cash Flows
Years Ended
December 31,
|
||||||||
2009
|
2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income (loss)
|
$ | (24,643,438 | ) | $ | 8,997,068 | |||
Depreciation
|
2,721,636 | 1,727,668 | ||||||
Amortization
|
27,967 | 26,679 | ||||||
Deferred
income tax
|
(416,944 | ) | -- | |||||
Loss
on disposal of property, plant and equipment
|
36,938 | -- | ||||||
Change
in fair value of warrants
|
35,492,017 | -- | ||||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Accounts
receivable
|
512,692 | (781,040 | ) | |||||
Inventories
|
(10,047,537 | ) | (5,265,816 | ) | ||||
Other
receivables
|
(9,749,527 | ) | (771,775 | ) | ||||
Prepaid
expenses
|
(327,811 | ) | (874,300 | ) | ||||
Advances
to suppliers
|
1,686,988 | (2,234,224 | ) | |||||
Accounts
payable
|
7,829,738 | 12,699,697 | ||||||
Cash
card and coupon liabilities
|
3,834,412 | 1,892,717 | ||||||
Customer
deposits received
|
944,028 | 1,938,371 | ||||||
Accrued
expenses and other payables
|
3,069,863 | 467,163 | ||||||
Income
taxes payable
|
(104,692 | ) | 839,059 | |||||
Net
cash provided by operating activities
|
10,866,330 | 18,661,267 | ||||||
CASH
FLOWS USED IN INVESTING ACTIVITIES:
|
||||||||
Purchases
of property, plant and equipment
|
(19,566,327 | ) | (4,595,461 | ) | ||||
Acquisition
of business, net
|
-- | (19,640,200 | ) | |||||
Decrease
(Increase) of pledged deposits
|
111,313 | (293,149 | ) | |||||
Net
cash used in investing activities
|
(19,455,014 | ) | (24,528,810 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from issuance of Common stock
|
37,406,389 | -- | ||||||
Proceeds
from issuance of Series A convertible preferred stock
|
15,500,000 | |||||||
Repayment
of bank loan
|
(2,195,872 | ) | (2,872,635 | ) | ||||
Net
cash provided by financing activities
|
35,210,517 | 12,627,365 | ||||||
Net
increase in cash
|
26,621,833 | 6,759,822 | ||||||
Effect
of foreign currency translation
|
5,944 | 1,783,135 | ||||||
Cash
at beginning of period
|
19,285,021 | 10,742,064 | ||||||
Cash
at end of period
|
$ | 45,912,798 | 19,285,021 | |||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid
|
23,734 | 240,330 | ||||||
Income
taxes paid
|
$ | 4,120,045 | 2,472,229 |
See notes to audited consolidated
financial statements.
F-6
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
QKL
Stores, Inc. (“Store”) (formerly known as Forme Capital, Inc.) was incorporated
under the laws of the State of Delaware on December 2, 1986. From 1989 to 2000,
Store created and spun off to its stockholders nine blind pool companies for two
years, then operated as a real estate company for eight years, then sold
substantially all of its assets and ceased operations. From 2000 until March 28,
2008, Store was a shell company with no substantial operations or assets. Store
currently operates through (1) itself, (2) one directly wholly-owned subsidiary
in the British Virgin Islands: Speedy Brilliant Group Ltd. (“Speedy Brilliant
(BVI)”), (3) one directly wholly-owned subsidiary of Speedy Brilliant (BVI)
located in Mainland China: Speedy Brilliant (Daqing) Ltd. (“Speedy Brilliant
(Daqing)” or “WFOE”), (4) one operating company located in Mainland China:
Daqing Qingkelong Chain Commerce & Trade Co., Ltd. (“Qingkelong Chain”),
which Store controls, through contractual arrangements between WFOE and
Qingkelong Chain, as if Qingkelong Chain were a wholly-owned subsidiary of
Store, and (5) one wholly-owned operating subsidiary of Qingkelong Chain located
in Mainland China: Daqing Qinglongxin Commerce & Trade Co., Ltd
(“Qinglongxin Commerce”).
Speedy
Brilliant (BVI) was established in the British Virgin Islands as a BVI business
company on February 23, 2007. Speedy Brilliant (Daqing) was established in the
Heilongjiang Province of the People’s Republic of China (the PRC) as a limited
company on August 1, 2007. Qingkelong Chain was established in the Heilongjiang
Province of the PRC as a limited company on November 2, 1998. Qinglongxin
Commerce was established in the Heilongjiang Province of the PRC as a limited
company on July 10, 2006.
The Store
and its subsidiaries (hereinafter, collectively referred to as “the Company”)
are engaged in the operation of retail chain stores in the PRC.
The
Company is a regional supermarket chain that currently operates 34
supermarkets and 2 department stores in northeastern China and Inner Mongolia.
The Company’s supermarkets sell a broad selection of merchandise including
groceries, fresh food and non-food items. The Company currently has one
distribution center servicing its supermarkets.
Management
believes that the Company is the only supermarket chain in northeastern China
and Inner Mongolia that is a licensee of the International Grocers Alliance, or
IGA, a United States-based global grocery network with aggregate retail sales of
more than $21.0 billion per year. As a licensee of IGA, the Company is able to
engage in group bargaining with suppliers and have access to more than 2,000
private IGA brands, including many that are exclusive IGA brands.
The
Company completed the initial steps in the execution of its expansion plan
in March 2008, when the Company raised financing through the combination of a
reverse merger and private placement. Under that plan, the Company opened seven
new stores in 2009 that have, in the aggregate, approximately 32,000 square
meters of space and ten new stores in 2008 that have, in the aggregate,
approximately 42,000 square meters of space. Six stores opened in 2008 were
opened by the Company and four of the new stores were opened through the
acquisition of existing businesses by the Company. Seven stores opened in 2009
were opened by the Company. In 2010, the Company plans to open additional
hypermarkets, supermarkets and department stores having, in the aggregate,
approximately 100,000 square meters of space. The Company is also making
improvements to its logistics and information systems to support its
supermarkets. The Company expects to finance its expansion plan from funds
generated from operations, bank loans and proceeds from private or public
financing, to the extent available.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRC
Restructuring Agreements
The PRC
restructuring transaction was effected by the execution of five agreements
between Speedy Brilliant (Daqing), on the one hand, and QKL-China (and in some
cases the shareholders of QKL-China), on the other hand. Those five agreements
and their consequences are described below.
F-7
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
·
|
Consigned
Management Agreement
|
The
Consigned Management Agreement among Speedy Brilliant (Daqing), QKL-China and
all of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing)
will provide financial, business management and human resources management
services to QKL-China that will enable Speedy Brilliant (Daqing) to control
QKL-China’s operations, assets and cash flow, and in exchange, QKL-China will
pay a management fee to Speedy Brilliant (Daqing) equal to 4.5% of QKL-China’s
annual revenue. The management fee for each year is due by January 31 of the
following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
·
|
Technology
Service Agreement
|
The
Technology Service Agreement among Speedy Brilliant (Daqing), QKL-China and all
of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing) will
provide technology services, including the selection and maintenance of
QKL-China’s computer hardware and software systems and training of QKL-China
employees in the use of those systems, and in exchange QKL-China will pay a
technology service fee to Speedy Brilliant (Daqing) equal to 1.5% of QKL-China’s
annual revenue. The technology service fee for each year is due by January 31 of
the following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
·
|
Loan
Agreement
|
The Loan
Agreement among Speedy Brilliant (Daqing) and all of the shareholders of
QKL-China, provides that Speedy Brilliant (Daqing) will make a loan in the
aggregate principal amount of RMB 77 million (approximately $11.2 million) to
the shareholders of QKL-China, each shareholder receiving a share of the loan
proceeds proportional to its shareholding in QKL-China, and in exchange each
shareholder agreed (i) to contribute all of its proceeds from the loan to the
registered capital of QKL-China in order to increase the registered capital of
QKL-China, (ii) to cause QKL-China to complete the process of registering the
increase in its registered capital with PRC regulatory authorities within 30
days after receiving the loan, and (iii) to pledge their equity to Speedy
Brilliant (Daqing) under the Equity Pledge Agreement described
below.
The loan
is repayable by the shareholders at the option of Speedy Brilliant
(Daqing) either by the transfer of QKL-China’s equity to Speedy Brilliant
(Daqing) or through proceeds indirectly from the transfer of QKL-China assets to
Speedy Brilliant (Daqing). The loan does not bear interest, except that if (x)
Speedy Brilliant (Daqing) is able to purchase the equity or assets of QKL-China,
and (y) the lowest allowable purchase price for that equity or those assets
under PRC law is greater than the principal amount of the loan, then, insofar as
it is allowable under PRC law, interest will be deemed to have accrued on the
loan in an amount equal to the difference between the lowest allowable purchase
price for QKL-China and the principal amount of the loan. The effect of this
interest provision is that, if and when permitted under PRC law, Speedy
Brilliant (Daqing) may acquire all of the equity or assets of QKL-China by
forgiving the loan, without making any further payment. If the principal amount
of the loan is greater than the lowest allowable purchase price for the equity
or assets of QKL-China under PRC law, then Speedy Brilliant (Daqing) would
exempt the shareholders from paying the difference between the two amounts. The
effect of this provision is that (insofar as allowable under PRC law) the
shareholders of QKL-China may satisfy their repayment obligations under the loan
by transferring all of QKL-China’s equity or assets to Speedy Brilliant
(Daqing), without making any further payment.
F-8
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
The Loan
Agreement also contains promises from the shareholders of QKL-China that during
the term of the agreement they will elect as directors of QKL-China only
candidates nominated by Speedy Brilliant (Daqing), and they will use their best
efforts to ensure that QKL-China does not take certain actions without the prior
written consent of Speedy Brilliant (Daqing), including (i) supplementing or
amending the articles of association or rules of QKL-China, or of any subsidiary
controlled or wholly owned by it, (ii) increasing or decreasing its registered
capital or shareholding structure, (iii) transferring, mortgaging or disposing
of any interests in its assets or income, or encumbering its assets or income in
a way that would affect Speedy Brilliant (Daqing)’s security interest unless
required for QKL-China’s normal business operations, (iv) incurring or
succeeding to any debts and liabilities, (v) entering into any material contract
(exceeding RMB 5.0 million, or approximately $0.7 million, in value); (vi)
providing any loan or guarantee to any third party; (vii) acquiring or
consolidating with any third party, or investing in any third party; and (viii)
distributing any dividends to the shareholders in any manner. In addition, the
Loan Agreement provides that at Speedy Brilliant (Daqing)’s request, QKL-China
will promptly distribute all distributable dividends to its
shareholders.
The funds
that Speedy Brilliant (Daqing) used to make the loan came from the proceeds
received by the Company, its indirect parent company, in the private placement
transaction completed in March 2008.
·
|
Exclusive
Purchase Option Agreement
|
The
Exclusive Purchase Option Agreement, among Speedy Brilliant (Daqing), QKL-China,
and all of the shareholders of QKL-China, provides that QKL-China will grant
Speedy Brilliant (Daqing) or its designated third party an irrevocable and
exclusive right to purchase all or part of QKL-China’s assets, and the
shareholders of QKL-China will grant Speedy Brilliant (Daqing) or its designated
third party an irrevocable and exclusive right to purchase all or part of their
equity interests in QKL-China. Either right may be exercised by Speedy Brilliant
(Daqing) in its sole discretion at any time that the exercise would be
permissible under PRC law, and the purchase price for Speedy Brilliant
(Daqing)’s acquisition of equity or assets will be the lowest price permissible
under PRC law. QKL-China and its shareholders are required to execute purchase
agreements and related documentation within 30 days of receiving notice from
Speedy Brilliant (Daqing) that it intends to exercise its right to
purchase.
The
Exclusive Purchase Option Agreement contains promises from QKL-China and its
shareholders that they will refrain from taking actions, such as voting to
dissolve or declaring dividends, that could impair Speedy Brilliant (Daqing)’s
security interest in the equity of QKL-China or reduce its value. These promises
are substantially the same as those contained in the Loan Agreement described
above.
The
agreement will remain effective until Speedy Brilliant (Daqing) or its designees
have acquired 100% of the equity interests of QKL-China or substantially all of
the assets of QKL-China. The exclusive purchase options were granted under the
agreement on the closing date.
·
|
Equity
Pledge Agreement
|
The
Equity Pledge Agreement, among Speedy Brilliant (Daqing), QKL-China, and all of
the shareholders of QKL-China, provides that the shareholders of QKL-China will
pledge all of their equity interests in QKL-China to Speedy Brilliant (Daqing)
as a guarantee of the performance of the shareholders’ obligations and
QKL-China’s obligations under each of the other PRC Restructuring Agreements.
Under the Equity Pledge Agreement, the shareholders of QKL-China have also
agreed (i) to cause QKL-China to have the pledge recorded at the appropriate
office of the PRC Bureau of Industry and Commerce, (ii) to deliver any dividends
received from QKL-China during the term of the agreement into an escrow account
under the supervision of Speedy Brilliant (Daqing), and (iii) to deliver
QKL-China’s official shareholder registry and certificate of equity contribution
to Speedy Brilliant (Daqing).
The
Equity Pledge Agreement contains promises from QKL-China and its shareholders
that they will refrain from taking actions, such as voting to dissolve or
declaring dividends, that could impair Speedy Brilliant (Daqing)’s security
interest in the equity of QKL-China or reduce its value. These promises are
substantially the same as those contained in the Loan Agreement described
above.
F-9
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Completion
of the PRC Restructuring
The PRC
restructuring transaction closed on March 28, 2008 and after the closing date,
Speedy Brilliant (Daqing) completed all required post-closing steps, including
the payment and verification of all the installments of Speedy Brilliant
(Daqing)’s registered capital.
The
remaining portion of Speedy Brilliant (Daqing)’s registered capital was
contributed and verified by August 1, 2009, two years after the issuance of its
business license.
Share
Exchange Transaction
In the
share exchange transaction, Forme acquired control of Speedy Brilliant (BVI), a
British Virgin Islands holding company and the parent company of Speedy
Brilliant (Daqing), by issuing to the stockholders of Speedy Brilliant (BVI)
shares of common stock in exchange for all of the outstanding capital stock
of
Speedy
Brilliant (BVI). The stockholders of Speedy Brilliant (BVI) with whom the
Company completed the share exchange were (i) the majority holder, Winning State
International Limited, a British Virgin Islands holding company (“Winning State
(BVI)”) all of whose stock may be acquired in the future by the Company’s Chief
Executive Officer, Mr. Zhuangyi Wang, pursuant to a currently exercisable call
option held by Mr. Wang and (ii) three minority stockholders, Ms. Fang Chen, Mr.
Yang Miao, and Ms. Ying Zhang.
Share
Exchange Agreement
On March
28, 2008, Forme entered into a share exchange agreement with (i) Speedy
Brilliant (BVI); (ii) Speedy Brilliant (Daqing); (iii) the owners of all of the
outstanding voting stock of Speedy Brilliant (BVI), namely (a) Winning State
(BVI) (a company that is wholly owned and controlled by Mr. Chin Yoke Yap (all
of whose stock may be acquired by the Company’s CEO, Mr. Zhuangyi Wang,
pursuant to a currently exercisable call option held by Mr. Wang)), which owned
approximately 98.5% of the Speedy Brilliant (BVI) stock, and (b) three
individuals, Ms. Fang Chen, Ms. Yang Miao and Ms. Ying Zhang, who collectively
owned approximately 1.5% of the Speedy Brilliant (BVI) stock; and (iv) Forme’s
then controlling stockholders, Vision Opportunity China LP, Stallion Ventures,
LLC, and Castle Bison, Inc. Under the terms of the share exchange agreement, the
Speedy Brilliant (BVI) stockholders exchanged all of the outstanding shares of
Speedy Brilliant (BVI) for a total of 19,382,298 newly issued shares of Forme
common stock. As a result of the share exchange, Forme acquired Speedy Brilliant
(BVI) as a wholly owned subsidiary, and the Speedy Brilliant (BVI) stockholders
became holders of 92.8% of the Company’s common stock on a non-diluted basis
(64.6% of the Company’s common stock assuming conversion of the Company’s
newly-issued Series A Preferred Stock and 46.3% of the Company’s common stock
assuming conversion of the Company’s newly-issued Series A Preferred Stock and
exercise of all of the Series A Warrants and Series B Warrants).
In the
PRC restructuring transaction described above, Speedy Brilliant (BVI) gained
control of the Company’s operating company, QKL-China. Therefore, when the
Company acquired control of Speedy Brilliant (BVI) in the share exchange, the
Company acquired indirect control of QKL-China. As a result, at the time of the
share exchange, (i) the Company ceased to be a shell company as that term is
defined in Rule 12b-2 under the Exchange Act, (ii) Speedy Brilliant (BVI) became
the Company’s wholly owned subsidiary, and (iii) through the Company’s
newly-acquired indirect subsidiary Speedy Brilliant (Daqing) we now
control, through the contractual arrangements described above.
The
Company’s current structure, after completion of the reverse merger transaction,
is set forth in the diagram below:
F-10
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Principles of Consolidation
and Presentation
The
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles (“U.S. GAAP”). The
consolidated financial statements include the financial statements of QKL Stores
Inc, and its wholly-owned subsidiaries (collectively referred to herein as the
“Company”). All intercompany accounts, transactions, and profits have
been eliminated upon consolidation.
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could materially differ from those
estimates.
F-11
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Reclassification
The
presentation of certain line items presented on the consolidated financial
statements and the relevant notes for the prior years have been changed in
conformity with the current year presentation of the consolidated financial
statements and the corresponding notes. For comparative purposes, the
Company reclassified the following:
·
|
Approximately
$1,351,753 of revenues was reclassified to general and administrative
expenses in the statements of income in fiscal 2008. These
revenues were primarily related to sub-lease rental
income.
|
·
|
Approximately
$2,567,502 of selling expenses was reclassified to cost of sales in the
statements of income in fiscal 2008. These selling expenses
consisted of DC costs. The Company believes that such
reclassification represents better presentation to its retail industry
standard.
|
These
reclassification had no effect on the Company’s previously reported consolidated
statements of operations, consolidated statements of stockholders’ equity or
consolidated statements of cash flows, and is not considered material to any
previously reported consolidated financial statements.
Foreign Currency
Translation
The
Company’s financial statements are presented in the U.S. dollar ($), which is
the Company’s reporting currency, while its functional currency is Chinese
Renminbi (RMB). Transactions in foreign currencies are initially recorded at the
functional currency rate ruling at the date of transaction. Any differences
between the initially recorded amount and the settlement amount are recorded as
a gain or loss on foreign currency transaction in the consolidated statements of
income. Monetary assets and liabilities denominated in foreign currency are
translated at the functional currency rate of exchange ruling at the balance
sheet date. Any differences are taken to profit or loss as a gain or loss on
foreign currency translation in the statements of income.
In
accordance with ASC 830, Foreign Currency Matters, the Company translates the
assets and liabilities into RMB using the rate of exchange prevailing at the
applicable balance sheet date and the statements of income and cash flows are
translated at an average rate during the reporting
period. Adjustments resulting from the translation are recorded in
shareholders’ equity as part of accumulated other comprehensive
income.
Foreign Currency Translation
(continued)
Below is
a table with foreign exchange rates used for translation:
(Average
Rate)
Years
Ended December 31,
|
||||||||||
2009
|
2008
|
|||||||||
Chinese
Renminbi (RMB)
|
RMB
|
6.8310 |
RMB
|
6.9623 | ||||||
United
States dollar ($)
|
$ | 1.0000 | $ | 1.0000 |
As
of December 31,
|
2009
|
2008
|
||||||||
Chinese
Renminbi (RMB)
|
RMB
|
6.8172 |
RMB
|
6.8542 | ||||||
United
States dollar ($)
|
$ | 1.0000 | $ | 1.0000 |
F-12
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Segment
Reporting
The
Company operates in one industry segment, operating retail chain
stores. ASC 280, Segment Reporting, establishes standards for
reporting information about operating segments. Given the economic
characteristics of the similar nature of the products sold, the type of
customer and the method of distribution, the Company operates as one reportable
segment as defined by ASC 280, Segment Reporting.
Revenue
Recognition
The
Company earns revenue by selling merchandise primarily through its retail
stores. Revenue is recognized when merchandise is purchased by and delivered to
the customer and is shown net of estimated returns during the relevant period.
The allowance for sales returns is estimated based upon historical
experience.
Cash
received from the sale of cash card (aka “gift card”) is recorded as a
liability, and revenue is recognized upon the redemption of the cash card or
when it is determined that the likelihood of redemption is remote (“cash card
breakage”) and no liability to relevant jurisdictions exists. The Company
determines the cash card breakage rate based upon historical redemption patterns
and recognizes cash card breakage on a straight-line basis over the estimated
cash card redemption period. The Company recognized approximately nil
in cash card breakage revenue for fiscal 2009 and 2008,
respectively.
The
Company records sales tax collected from its customers on a net basis, and
therefore excludes it from revenue as defined in ASC 605, Revenue
Recognition.
Included
in revenue are sales of returned merchandise to vendors specializing in the
resale of defective or used products, which accounted for less than 0.5% of net
sales in each of the periods reported.
Cost of
Sales
Cost of
sales includes the cost of merchandise, related cost of packaging and
shipping cost and the distribution center costs.
Selling
Expenses
Selling
expenses include store-related expense, other than store occupancy costs, as
well as advertising, depreciation and amortization, and certain expenses
associated with operating the Company’s corporate headquarters.
Advertising
Costs
Advertising
costs are expensed as incurred. Advertising expense, net of reimbursement from
suppliers, amounted to $471,694 and nil for fiscal 2009 and 2008, respectively.
Advertising expense is included in selling expense in the accompanying
consolidated statements of income. The Company receives co-operative advertising
allowances from product vendors in order to subsidize qualifying advertising and
similar promotional expenditures made relating to vendors’ products. These
advertising allowances are recognized as a reduction to selling expense when the
Company incurs the advertising cost eligible for the credit. Co-operative
advertising allowances recognized as a reduction to selling and administrative
expense amounted to nil for fiscal 2009 and 2008 respectively.
F-13
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Vendor
Allowances
The
Company receives allowances for co-operative advertising and volume purchase
rebates earned through programs with certain vendors. The Company records a
receivable for these allowances which are earned but not yet received when it is
determined the amounts are probable and reasonably estimable, in accordance with
ASC 605. Amounts relating to the purchase of merchandise are treated as a
reduction of inventory cost and reduce cost of goods sold as the merchandise is
sold. Amounts that represent a reimbursement of costs incurred, such as
advertising, are recorded as a reduction in selling and administrative expense.
The Company performs detailed analyses to determine the appropriate amount of
vendor allowances to be applied as a reduction of merchandise cost and selling
expenses.
Leases
The
Company accounts for its leases under the provisions of ASC 840, Leases. Certain
of the Company’s operating leases provide for minimum annual payments that
change over the life of the lease. The aggregate minimum annual payments are
expensed on the straight-line basis over the minimum lease term. The Company
recognizes a deferred rent liability for minimum step rents when the amount of
rent expense exceeds the actual lease payments and it reduces the deferred rent
liability when the actual lease payments exceeds the amount of straight-line
rent expense. Rent holidays and tenant improvement allowances for store remodels
are amortized on the straight-line basis over the initial term of the lease and
any option period that is reasonably assured of being exercised.
Restricted
Cash
Restricted
cash are cash deposited in a trust account maintained in the United States for
the purpose of investor and public relation affairs.
Accounts
Receivable
Accounts
receivable consist primarily of third party purchasing card receivables, amounts
due from inventory vendors for returned products or co-operative advertising and
amounts due from lessors for tenant improvement allowances. Accounts receivable
have not historically resulted in any material credit losses. An allowance for
doubtful accounts is provided when accounts are determined to be
uncollectible.
Inventories
Inventories
primarily consist of merchandise inventories and are stated at lower of cost or
market and net realizable value. Cost of inventories is calculated on the
weighted average basis which approximates cost.
Management
regularly reviews inventories and records valuation reserves for damaged and
defective returns, inventories with slow-moving or obsolescence exposure and
inventories with carrying value that exceeds market value. Because of its
product mix, the Company has not historically experienced significant
occurrences of obsolescence.
Inventory
shrinkage is accrued as a percentage of revenues based on historical inventory
shrinkage trends. The Company performs physical inventory count of its stores
once per quarter and cycle counts inventories at its distribution centers once
per quarter throughout the year. The reserve for inventory shrinkage represents
an estimate for inventory shrinkage for each store since the last physical
inventory date through the reporting date.
These
reserves are estimates, which could vary significantly, either favorably or
unfavorably, from actual results if future economic conditions, consumer demand
and competitive environments differ from expectations.
F-14
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Property, Plant and
Equipment
Property,
plant and equipment are recorded at cost. Significant additions or improvements
extending useful lives of assets are capitalized. Maintenance and repairs are
charged to expense as incurred. Depreciation is computed using the straight-line
method over the estimated useful lives as follows:
Buildings
|
30
to 40 years
|
Shop
equipment
|
6
years
|
Office
equipment
|
5
years
|
Motor
vehicles
|
8
years
|
Car
park
|
43
years
|
Leasehold
improvements
|
Shorter
of estimated useful life or term of
lease
|
Land Use Rights
According
to the laws of the PRC, the government owns all the land in the
PRC. Companies or individuals are authorized to possess and use the
land only through the land use rights granted by the government. The land use
rights represent cost of the rights to use the land in respect of
properties located in the PRC. Land use rights are carried at cost and amortized
on a straight-line basis over the period of rights of 30 to 40
years.
Goodwill
Goodwill
represents the excess of purchase price over fair value of net assets acquired.
Under ASC 350, Intangibles — Goodwill and Other, goodwill is not amortized
but evaluated for impairment annually or whenever events or changes in
circumstances indicate that the value may not be recoverable.
The
Company performed an annual impairment test as of the end of fiscal 2009 and
2008, and determined that goodwill was not impaired.
Long-lived
Assets
The
Company reviews long-lived assets for impairment annually or whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.
Long-lived
assets are reviewed for recoverability at the lowest level in which there are
identifiable cash flows, usually at the store level. The carrying amount of a
long-lived asset is not considered recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use of the asset. If the
asset is determined not to be recoverable, then it is considered to be impaired
and the impairment to be recognized is the amount by which the carrying amount
of the asset exceeds the fair value of the asset, determined using discounted
cash flow valuation techniques, as defined in ASC 360, Property, Plant, and
Equipment.
The
Company determined the sum of the undiscounted cash flows expected to result
from the use of the asset by projecting future revenue and operating expense for
each store under consideration for impairment. The estimates of future cash
flows involve management judgment and are based upon assumptions about expected
future operating performance. The actual cash flows could differ from
management’s estimates due to changes in business conditions, operating
performance and economic conditions.
The
Company’s evaluation resulted in no long-lived asset impairment charges during
fiscal 2009 and 2008.
F-15
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Concentration of Credit
Risk
The
Company maintains cash in bank deposit accounts in PRC, except one restricted
cash deposit account in the U.S. for the sole purpose of disbursements of
investor relations expenses. The account in the U.S. is uninsured by
the Federal Deposit Insurance Corporation (“FDIC”) up to $81,693. The Company
performs ongoing evaluations of this institution to limit its concentration risk
exposure.
The
Company operates retail stores located principally in the Northeast of China.
Because of this, the Company is subject to regional risks, such as the economy,
regional financial conditions and unemployment, weather conditions, power
outages, and other natural disasters specific to the region in which the Company
operates.
The
Company relies on two distribution centers located in Daqing, China, which
service its stores. Any natural disaster or other serious disruption to the
distribution center due to fire, earthquake or any other cause could damage a
significant portion of inventory and could materially impair the Company’s
ability to adequately stock its stores.
Retirement Benefit
Plans
Full time
employees of the Company in the PRC participate in a government mandated defined
contribution plan, pursuant to which certain pension benefits, medical care,
employee housing fund and other welfare benefits are provided to employees.
Chinese labor regulations require the Company to make contributions to the
government for these benefits based on certain percentages of the
employees’ salaries. The Company accounts the mandated defined contribution plan
under the vested benefit obligations approach based on the guidance of ASC 715,
Compensation—Retirement Benefits.
The total
amounts for such employee benefits which were expensed were $2,087,718 and
$911,831 for the years ended December 31, 2009 and 2008,
respectively.
Retained Earnings -
Appropriated
The
income of the Company’s PRC subsidiaries is distributable to their shareholder
after transfer to reserves as required by relevant PRC laws and regulations and
the subsidiary’s Articles of Association. As stipulated by the
relevant laws and regulations in the PRC, these PRC subsidiaries are required to
maintain reserves which are non-distributable to
shareholders. Appropriations to the reserves are approved by the respective
boards of directors.
Reserves
include statutory surplus reserves and discretionary
reserves. Statutory surplus reserves can be used to make good
previous years’ losses, if any, and may be converted into capital in proportion
to the existing equity interests of shareholders, provided that the balance
after such conversion is not less than 25% of the registered
capital. The appropriation to the statutory surplus reserves must not
be less than 10% of net profit after taxation. Such appropriation may
cease to apply if the balance of the fund is equal to 50% of the entity’s
registered capital. The annual appropriations of reserves of
Qingkelong Chain and Qinglongxin Commerce are 10% and nil for the years ended
December 31, 2009 and 2008, respectively.
Income
Taxes
The
Company follows ASC 740, Income Taxes, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each period end based on enacted tax laws
and statutory tax rates, applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.
F-16
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
The
Company adopted ASC 740-10-25 on January 1, 2007, which provides criteria for
the recognition, measurement, presentation and disclosure of uncertain tax
position. The Company must recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position are measured based on the largest benefit that
has a greater than 50% likelihood of being realized upon ultimate resolution.
The Company did not recognize any additional liabilities for uncertain tax
positions as a result of the implementation of ASC 740-10-25.
Fair Value
Measurements
ASC 820
defines fair value as the price that would be received from selling an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date. When determining the fair value
measurements for assets and liabilities required or permitted to be recorded at
fair value, the Company considers the principal or most advantageous market in
which it would transact and it considers assumptions that market participants
would use when pricing the asset or liability.
ASC 820
establishes a fair value hierarchy that requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring
fair value. A financial instrument’s categorization within the fair value
hierarchy is based upon the lowest level of input that is significant to the
fair value measurement. ASC 820 establishes three levels of inputs
that may be used to measure fair value:
·
|
Level
1 – Valuations based on unadjusted quoted prices in active markets for
identical assets or liabilities that the Company holds. An active market
for the asset or liability is a market in which transactions for the asset
or liability occur with sufficient frequency and volume to provide pricing
information on an ongoing
basis.
|
·
|
Level
2 – Valuation based on quoted prices in markets that are not active for
which all significant inputs are observable, either directly or
indirectly.
|
·
|
Level
3 – Valuations based on inputs that are unobservable and significant to
the overall fair value measurement.
|
The
Company adopted ASC 820, Fair Value Measurements and Disclosures, on
January 1, 2008 for all financial assets and liabilities and nonfinancial
assets and liabilities that are recognized or disclosed at fair value in the
consolidated financial statements on a recurring basis (at least annually). ASC
820 defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. The Company has also adopted
ASC 820, on January 1, 2009 for non financial assets and non financial
liabilities, as these items are not recognized at fair value on a recurring
basis. The adoption of ASC 820 for all financial assets and liabilities and
non-financial assets and non-financial liabilities did not have any impact
on the Company’s consolidated financial statements.
Financial
instruments include cash, accounts receivable, prepayments and other
receivables, short-term borrowings from banks, accounts payable and accrued
expenses and other payables. The carrying amounts of cash, accounts receivable,
prepayments and other receivables, short-term loans, accounts payable and
accrued expenses approximate their fair value due to the short term maturities
of these instruments. See footnote 10 regarding the fair value of the
Company’s
warrants, which are classified as Level 3 liabilities in the fair value
hierarchy.
Recently Issued
Accounting
Guidance
In
December 2007, the FASB issued ASC 810-10-65(formerly SFAS 160, "Noncontrolling
Interests in Consolidated Financial Statements — an amendment of ARB No. 51"),
Consolidation, which applies to all companies that prepare consolidated
financial statements, except not-for-profit organizations, but will affect only
those entities that have an outstanding non-controlling interest in one or more
subsidiaries or that deconsolidate a subsidiary. ASC 810-10-65
requires that ownership interests in subsidiaries held by parties other than the
parent, and the amount of consolidated net income, be clearly identified,
labeled and presented in the consolidated financial statements. It also requires
that once a subsidiary is deconsolidated, any retained non-controlling equity
investment in the former subsidiary be initially measured at fair
value. Sufficient disclosures are required to clearly identify and
distinguish between the interests of the parent and the interests of the
non-controlling owners. It is effective for fiscal years beginning after
December 15, 2008, and requires retroactive adoption of the presentation and
disclosure requirements for existing minority interests. All other requirements
are applied prospectively. The Company adopted ASC 810-10-65 on January 1, 2009
and the Company’s consolidated financial statements reflect the required
changes.
F-17
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Effective
January 1, 2009, the Company adopted FASB ASC 805-10, (formerly SFAS 141R,
"Business Combinations"), which establishes principles and requirements for how
an acquirer recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, any noncontrolling interest in an
acquiree and the goodwill acquired. In addition, the provisions in this
ASC require that any additional reversal of deferred tax asset valuation
allowance established in connection with our fresh start reporting on January 7,
1998 be recorded as a component of income tax expense rather than as a reduction
to the goodwill established in connection with the fresh start reporting. The
adoption did not have a material impact on the Company’s consolidated financial
statements.
Effective
January 1, 2009, the Company adopted FASB ASC 805-20 (formerly FSP FAS 141R-1,
"Accounting for Assets Acquired and Liabilities Assumed in a Business
Combination That Arise from Contingencies"), which amends ASC 805-10 to require
that an acquirer recognize at fair value, at the acquisition date, an asset
acquired or a liability assumed in a business combination that arises from a
contingency if the acquisition-date fair value of that asset or liability can be
determined during the measurement period. If the acquisition-date fair value of
such an asset acquired or liability assumed cannot be determined, the acquirer
should apply the provisions of ASC Topic 450, Contingences, to determine whether
the contingency should be recognized at the acquisition date or after such date.
The adoption of ASC 805-20 did not have a material impact on the Company’s
consolidated financial statements.
Effective
January 1, 2009, the Company adopted ASC 350-30 and ASC 275-10-50 (formerly FSP
FAS 142-3, “Determination of the Useful Life of Intangible Assets”), which
amends the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142 ("SFAS 142"), “Goodwill and Other Intangible Assets.” The
adoption of these revised provisions had no impact on the Company’s consolidated
financial statements.
In June
2009, the FASB issued ASC 810-10-30, Variable Interest Entities (formerly FASB
167), regarding when and how to determine, or re-determine, whether an entity is
a variable interest entity. In addition, FASB No. 167 replaces FIN 46R’s
quantitative approach for determining who has a controlling financial interest
in a variable interest entity with a qualitative approach. Furthermore, ASC
810-10-30 requires ongoing assessments of whether an entity is the primary
beneficiary of a variable interest entity. ASC 810-10-30 is effective beginning
January 1, 2010 and the adoption is not expected to have a material impact
on the Company’s consolidated financial statements.
In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles — a replacement of FASB Statement No. 162.
SFAS No. 168 established the FASB Accounting Standards Codification
(“ASC”) as the single source of authoritative generally accepted accounting
principles in the United States of America (“GAAP”) to be applied by
nongovernmental entities in the preparation of financial statements. Rules and
interpretive releases of the Securities and Exchange Commission (“SEC”) under
authority of federal securities laws are also sources of authoritative GAAP for
SEC registrants. All guidance in the ASC carries an equal level of authority.
The ASC supersedes all previously existing non-SEC accounting and reporting
standards. The ASC simplifies user access to all authoritative GAAP by
reorganizing previously issued GAAP pronouncements into approximately 90
accounting topics within a consistent structure, without creating new accounting
and reporting guidance. The ASC became effective for financial statements issued
for interim and annual periods ending after September 15, 2009;
accordingly, the Company adopted the ASC in the third quarter of fiscal 2009.
Following SFAS No. 168, the FASB will not issue new standards in the
form of Statements, FASB Staff Positions, or Emerging Issues Task Force
Abstracts; instead, it will issue Accounting Standards Updates. The FASB will
not consider Accounting Standards Updates as authoritative in their own right;
these updates will serve only to update the ASC, provide background information
about the guidance, and provide the bases for conclusions on the change(s) in
the ASC. In the discussion that follows, the Company will refer to
ASC citations that relate to ASC Topics and their descriptive titles, as
appropriate, and will no longer refer to citations that relate to accounting
pronouncements superseded by the ASC. The adoption of the ASC had no impact on
the Company’s consolidated financial statements.
F-18
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets – an amendment of FASB Statement No. 140,” (not yet reflected in FASB
ASC). SFAS No. 166 limits the circumstances in which a financial asset should be
derecognized when the transferor has not transferred the entire financial asset
by taking into consideration the transferor’s continuing involvement. The
standard requires that a transferor recognize and initially measure at fair
value all assets obtained (including a transferor’s beneficial interest) and
liabilities incurred as a result of a transfer of financial assets accounted for
as a sale. The concept of a qualifying special-purpose entity is removed from
SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities,” along with the exception from applying FIN
46(R), “Consolidation of Variable Interest Entities.” The standard is effective
for the first annual reporting period that begins after November 15, 2009 (i.e.
the Company’s fiscal year beginning January 1, 2010), for interim periods within
the first annual reporting period, and for interim and annual reporting periods
thereafter. Earlier application is prohibited. It is expected the adoption
of this Statement will have no material effect on the Company’s
consolidated financial statements.
In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R),” (not yet reflected in FASB ASC). The standard amends FIN No. 46(R) to
require a company to analyze whether its interest in a variable interest entity
(“VIE”) gives it a controlling financial interest. A company must assess whether
it has an implicit financial responsibility to ensure that the VIE operates as
designed when determining whether it has the power to direct the activities
of the VIE that significantly impact its economic performance. Ongoing
reassessments of whether a company is the primary beneficiary are also required
by the standard. SFAS No. 167 amends the criteria to qualify as a primary
beneficiary as well as how to determine the existence of a VIE. The standard
also eliminates certain exceptions that were available under FIN No. 46(R). This
Statement will be effective as of the beginning of each reporting entity’s first
annual reporting period that begins after November 15, 2009 (i.e. the
Company’s fiscal year beginning January 1, 2010), for interim periods within
that first annual reporting period, and for interim and annual reporting periods
thereafter. Earlier application is prohibited. Comparative disclosures will be
required for periods after the effective date. As such, the Company will adopt
this Statement for interim and annual periods ending after January 1,
2010. It is expected the adoption of this Statement will have no material
effect on the Company’s consolidated financial statements.
In
September 2009, the accounting standard regarding multiple deliverable
arrangements was updated to require the use of the relative selling price method
when allocating revenue in these types of arrangements. This method allows a
vendor to use its best estimate of selling price if neither vendor specific
objective evidence nor third party evidence of selling price exists when
evaluating multiple deliverable arrangements. This standard update is effective
January 1, 2011 and may be adopted prospectively for revenue arrangements
entered into or materially modified after the date of adoption or
retrospectively for all revenue arrangements for all periods presented. The
Company is currently evaluating the impact that this standard update will have
on its consolidated financial statements.
In
October 2009, the FASB concurrently issued the following ASC
Updates:
·
|
ASU
No. 2009-14 - Software (Topic 985): Certain Revenue Arrangements That
Include Software Elements (formerly EITF Issue No. 09-3). This standard
removes tangible products from the scope of software revenue recognition
guidance and also provides guidance on determining whether software
deliverables in an arrangement that includes a tangible product, such as
embedded software, are within the scope of the software revenue
guidance.
|
·
|
ASU
No. 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable
Revenue Arrangements (formerly EITF Issue No. 08-1). This standard
modifies the revenue recognition guidance for arrangements that involve
the delivery of multiple elements, such as product, software, services or
support, to a customer at different times as part of a single revenue
generating transaction. This standard provides principles and
application guidance to determine whether multiple deliverables exist, how
the individual deliverables should be separated and how to allocate the
revenue in the arrangement among those separate deliverables. The standard
also expands the disclosure requirements for multiple deliverable revenue
arrangements.
|
F-19
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
These
Accounting Standards Updates should be applied on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, with earlier application permitted.
Alternatively, an entity can elect to adopt these standards on a retrospective
basis, but both these standards must be adopted in the same period using the
same transition method. The Company expects to apply this standard on a
prospective basis for revenue arrangements entered into or materially modified
beginning January 1, 2011. The Company is currently evaluating the
potential impact these standards may have on its financial position and results
of operations.
In
January 2010, the FASB issued the following ASC Updates:
·
|
ASU
No. 2010-01—Equity (Topic 505): Accounting for Distributions to
Shareholders with Components of Stock and Cash. This Update clarifies that
the stock portion of a distribution to shareholders that allows them to
elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate
is considered a share issuance that is reflected in EPS prospectively and
is not a stock dividend for purposes of applying Topics 505 and 260
(Equity and Earnings Per Share). The amendments in this Update are
effective for interim and annual periods ending on or after December 15,
2009 with retrospective
application.
|
·
|
ASU
No. 2010-02—Consolidation (Topic 810): Accounting and Reporting for
Decreases in Ownership of a Subsidiary. This Update amends Subtopic 810-10
and related guidance to clarify that the scope of the decrease in
ownership provisions of the Subtopic and related guidance applies to (i) a
subsidiary or group of assets that is a business or nonprofit activity;
(ii) a subsidiary that is a business or nonprofit activity that is
transferred to an equity method investee or joint venture; and (iii) an
exchange of a group of assets that constitutes a business or nonprofit
activity for a noncontrolling interest in an entity, but does not apply
to: (i) sales of in substance real estate; and (ii) conveyances of oil and
gas mineral rights. The amendments in this Update are effective beginning
in the period that an entity adopts FAS 160 (now included in Subtopic
810-10).
|
·
|
ASU
No. 2010-06—Fair Value Measurements and Disclosures (Topic 820): Improving
Disclosures about Fair Value Measurements. This Update amends
Subtopic 820-10 that require new disclosures about transfers in and out of
Levels 1 and 2 and activity in Level 3 fair value measurements. This
Update also amends Subtopic 820-10 to clarify certain existing
disclosures. The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about
purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements, which are effective for
fiscal years beginning after December 15,
2010.
|
The
Company expects that the adoption of the above Updates issued in January 2010
will not have any significant impact on its financial position and results of
operations.
F-20
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
3 – OTHER RECEIVABLES
Other
receivables consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Deposits
to employee for purchases and disbursements (1)
|
$ | 1,486,336 | $ | 1,889,291 | ||||
Coupon
sales receivables
|
1,688,032 | 719,317 | ||||||
Input
value added tax receivables (2)
|
1,164,315 | 196,207 | ||||||
Loans
to suppliers (3)
|
8,531,986 | 893,435 | ||||||
Prepaid
rent
|
- | 490,890 | ||||||
Rebates
receivables (4)
|
1,109,903 | - | ||||||
Total
|
$ | 13,980,572 | $ | 4,189,140 |
(1)
|
Deposits
to employees for purchases and disbursements are cash held by employees in
different retail shops in various cities and provinces in the PRC. They
are held for local purchases of merchandise, and held by salespersons in
shops for day to day operations.
|
(2)
|
Input
VAT arises when the Group purchases products from suppliers and the input
VAT can be deducted from output VAT on
sales.
|
(3)
|
Loans
to unrelated vendors are used to secure the merchandise needed during
the peak season at the end of the year. Except the loans amount to
$7,334,388(RMB50million) was unsecured bearing an interest rate of
6.237% per annum, the other loans are unsecured, interest
free and repayable on demand.
|
(4)
|
Rebates
receivables represent promotional allowances provided by vendors for
promotions incurred by the Company.
|
NOTE
4 – PROPERTY, PLANT AND EQUIPMENT, NET
Property,
plant and equipment consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Buildings
|
$ | 6,275,438 | $ | 6,241,563 | ||||
Shop
equipment
|
11,515,649 | 8,498,599 | ||||||
Office
equipment
|
1,199,554 | 834,563 | ||||||
Motor
vehicles
|
751,430 | 562,876 | ||||||
Car
park
|
18,893 | 18,791 | ||||||
Leasehold
improvements
|
7,611,421 | 3,736,509 | ||||||
Construction
in progress
|
11,001,584 | - | ||||||
Total
property, plant and equipment
|
38,373,969 | 19,892,901 | ||||||
Less: accumulated
depreciation and amortization
|
(8,971,339 | ) | (6,932,598 | ) | ||||
Total
property, plant and equipment, net
|
$ | 29,402,630 | $ | 12,960,303 |
F-21
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
5 – LAND USE RIGHTS
Land use
rights consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Land
use rights
|
$ | 862,527 | $ | 857,097 | ||||
Less
– accumulated amortization
|
(109,301 | ) | (80,838 | ) | ||||
Total
intangible assets, net
|
$ | 753,226 | $ | 776,259 |
Future
amortization of land use rights is as follows:
Years
Ending December 31,
|
Amount
|
|||
2010
|
$ | 27,967 | ||
2011
|
27,967 | |||
2012
|
27,967 | |||
2013
|
27,967 | |||
2014
|
27,967 | |||
Thereafter
|
613,391 | |||
Total
|
$ | 753,226 |
NOTE
6 – GOODWILL
During
the year 2008, the Company acquired a number of businesses in Northeast China
through the purchases of assets and the operating rights from unrelated parties.
Goodwill represents the excess of the cost of the purchases over the fair value
of the net acquired identifiable assets at the date of acquisition.
Goodwill
for impairment has been tested annually, or whenever events or circumstances
indicate that it is more likely than not that the fair value of a reporting unit
is below its carrying amount. The test to evaluate for impairment is a two-step
process. In the first step, we compare the fair value of each of our reporting
units to its carrying value. If the fair value of any reporting unit is less
than its carrying value, we perform a second step to determine the implied fair
value of goodwill associated with that reporting unit. If the carrying value of
goodwill exceeds the implied fair value of goodwill, such excess represents
the amount of goodwill impairment. There is no impairment occurred for the year
ended December 31, 2009.
In order
to expand, the Company had five acquisitions during 2008 consisting of the
purchase of the operating rights and certain assets of (1) Daqing Xinguangtiandi
Shopping Center Co., Ltd; (2) Hulunbeier Huahui Department Store Co., Ltd; (3)
Heilongjiang Longmei Commerce Co., Ltd; (4) Fuyu Xinshuguang Real Estate
Development Co., Ltd and (5) Nehe Wanlong Commercial Building Co.,
Ltd.
No
supplemental pro forma information is presented for the acquisitions due to the
immaterial effect of the acquisition on the Company’s results of
operations.
F-22
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
On
September 30, 2008, the Company purchased the operating rights and certain
assets of Daqing Xinguangtiandi Shopping Center Co., Ltd, a supermarket store
that selling grocery, food and non-food products in Daqing of Heilongjiang, for
a purchase price of $1,982,118 (RMB 13,800,000) paid in cash. The operating
results of Daqing Xinguangtiandi Shopping Center Co. Ltd. have been included in
the consolidated financial statements since that date. The purchase price has
been allocated based on estimated fair values as of the acquisition date. The
purchase price has been allocated based on estimated fair values as of the
acquisition date. The purchase price was allocated as
follows:
September
30,
|
2008
|
|||
Current
assets
|
$ | 71,816 | ||
Property,
plant and equipment, net
|
54,580 | |||
Goodwill
|
1,855,722 | |||
Total
purchase price
|
$ | 1,982,118 |
On
October 31, 2008, the Company purchased the operating rights and certain assets
of Hulunbeier Huahui Department Store Co., Ltd, a supermarket store that selling
grocery, food and non-food products in Hulunbeier City of Inner Mongolia
Autonomous Region. The operation results of Hulunbeier Huahui
Department Store Co., Ltd have been included in the consolidated financial
statements since that date. The purchase price was $9,479,694 (RMB 66,000,000)
of cash. The purchase price has been allocated based on estimated fair
values as of the acquisition date. The purchase price was allocated as
follows:
October
31,
|
2008
|
|||
Current
assets
|
$ | 150,813 | ||
Property,
plant & equipment, net
|
76,125 | |||
Goodwill
|
9,252,756 | |||
Total
purchase price
|
$ | 9,479,694 |
On August
31, 2008, the Company purchased the operating rights and certain assets of
Heilongjiang Longmei Commerce Co., Ltd, a supermarket store that selling
grocery, food and non-food products in Suihua City of
Heilongjiang. The operation results of Heilongjiang Longmei
Commerce Co., Ltd have been included in the consolidated financial statements
since that date. The purchase price was $3,266,185 (RMB22,740,400) of cash. The
purchase price has been allocated based on estimated fair values as of the
acquisition date. The purchase price was allocated as
follows:
August
31,
|
2008
|
|||
Current
assets
|
$ | 52,770 | ||
Property,
plant & equipment, net
|
86,610 | |||
Goodwill
|
3,126,805 | |||
Total
purchase price
|
$ | 3,266,185 |
On
October 31, 2008, the Company purchased the operating rights and certain assets
of Fuyu Xinshuguang Real Estate Development Co., Ltd, a supermarket store that
selling grocery, food and non-food products in Qiqihar City of Heilongjiang.
The operation results of Fuyu Xinshuguang Real Estate Development Co., Ltd
have been included in the consolidated financial statements since that date. The
purchase price was $2,499,186 (RMB17,402,000) of cash. The purchase
price has been allocated based on estimated fair values as of the acquisition
date. The purchase price was allocated as follows:
F-23
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
October
31,
|
2008
|
|||
Current
assets
|
$ | 58,458 | ||
Property,
plant & equipment, net
|
91,206 | |||
Goodwill
|
2,349,522 | |||
Total
purchase price
|
$ | 2,499,186 |
On
September 30, 2008, the Company purchased the operating rights and certain
assets of Nehe Wanlong Commercial Building Co., Ltd, a supermarket store that
selling grocery, food and non-food products in Qiqihaer City of
Heilongjiang. The operation results of Nehe Wanlong Commercial
Building Co., Ltd. have been included in the consolidated financial statements
since that date. The purchase price was $2,413,017 (RMB16,800,000) of cash. The
purchase price has been allocated based on estimated fair values as of the
acquisition date. The purchase price was allocated as
follows:
September
30,
|
2008
|
|||
Current
assets
|
$ | 56,232 | ||
Property,
plant & equipment, net
|
62,767 | |||
Goodwill
|
2,294,018 | |||
Total
purchase price
|
$ | 2,413,017 |
NOTE
7 – SHORT-TERM BANK LOANS
The
Company had two short-term bank loans from a financial institution bearing an
interest rate of 7.425% and 5.94% per annum, due on May 22, 2009 and December
23, 2009, respectively. The Company had amount of nil and $2,188,439
outstanding as of December 31, 2009 and December 31,
2008,respectively. Interest expense was $23,734 and $240,330 for the
years ended December 31, 2009 and 2008, respectively.
NOTE
8 – ACCURED EXPENSES AND OTHER PAYABLES
Other
payables consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Accrued
expenses
|
$ | 1,688,890 | $ | 681,969 | ||||
VAT
and other PRC tax payable
|
202,873 | 203,443 | ||||||
Repair,
maintenance, and purchase of equipment payable
|
3,471,555 | 1,034,993 | ||||||
Employee
promoters bond deposit
|
1,292,771 | 441,672 | ||||||
Total
other payables
|
$ | 6,656,089 | $ | 2,362,077 |
F-24
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
9 – EARNINGS PER SHARE
The
Company calculates earnings per share in accordance with ASC 260, Earnings Per
Share, which requires a dual presentation of basic and diluted earnings per
share. Basic earnings per share are computed using the weighted average number
of shares outstanding during the fiscal year. Diluted earnings per share
represents basic earnings per share adjusted to include the potentially dilutive
effect of outstanding stock options. Potentially dilutive common
shares consist of convertible preferred stock (using the if-converted method)
and exercisable warrants outstanding.
The
following table sets forth the computation of basic and diluted net income per
common share:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Net
income (loss)
|
$ | (24,643,438 | ) | $ | 8,997,068 | |||
Weighted-average
shares of common stock outstanding
|
||||||||
Basic
|
21,885,423 | 20,882,353 | ||||||
Dilutive
shares:
|
||||||||
Conversion
of Series A Convertible Preferred Stock
|
8,816,289 | 9,117,647 | ||||||
Dilutive
effect of stock warrants
|
1,221,283 | 753,466 | ||||||
Diluted
|
31,922,995 | 30,753,466 | ||||||
Basic
earnings (loss) per share
|
$ | (1.13 | ) | $ | 0.43 | |||
Diluted
earnings (loss) per share
|
$ | (0.77 | ) | $ | 0.29 |
NOTE
10 – PREFERRED STOCK AND STOCK WARRANTS
On March
28, 2008, the
company completed the sale of 9,117,647 units for approximately $15,500,000.
Each unit consisted of one share of our Series A preferred stock, one Series A
warrant and one Series B warrant. Each share of Series A preferred stock is
convertible into one share of common stock, subject to certain anti-dilution
provisions. Each warrant is convertible into 0.625 shares of common stock or a
total of 11,397,058 shares of common stock. The warrants have a five year life
and the Series A warrants are exercisable at an equivalent price of $3.40 per
share and the Series B are exercisable at an equivalent price of $4.25 per
share.
The
proceeds from the transaction were allocated to the warrants and preferred stock
based on the relative fair value of the securities. The value of the
Series A shares was determined by reference to the market price of the common
shares into which it converts and the gross value of the warrants was calculated
using the Black–Scholes model. (Assumption used life of 5 years, volatility of
89%, and risk free interest rate of 2.51%). The proceeds were
allocated $91,176 to the par value of the Series A preferred, $9,388,824 to
additional paid in capital – preferred series A and $6,020,000 to the
warrants. This allocation resulted in the holders of the Preferred
Series A shares receiving a beneficial conversion feature totaling $1,917,000.
This beneficial conversion feature as been accounted for as a dividend to the
holders and has been charged to retained earnings.
F-25
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
In
connection with the sale of the units the Company paid fees totaling
approximately $1,591,000 in the form of cash of $1,371,500 and Series A and
Series B warrants to purchase 191,250 and 153,000 shares of common stock
respectively. The warrants were valued using the Black-Scholes model using the
same assumptions as used for the warrants contained in the units.
Under
Section 8(e) of the Registration Rights Agreement dated as of March 28, 2008 by
and among the Company and certain purchasers listed on a schedule attached
thereto the Company agreed to have a registration statement registering certain
of the securities of those purchasers declared effective with the Securities and
Exchange Commission on or prior to September 24, 2008 or pay liquidated
damages.
The
registration statement has been declared effective, pursuant to a Waiver and
Release dated as of March 9, 2009, the investors have waived their right to
liquidated damages for the Company’s failure to have the registration statement
declared effective on or prior to September 24, 2008. Accordingly,
there has been no accrual of any contingent liability recorded for
this issue in the financial statements as of December 31, 2009 and December 31,
2008.
During
2009, an aggregate of 1,569,301 shares of the Company’s Series A convertible
preferred stock were converted into corresponding shares of common
stock. For cash flow purposes, these transactions were non-cash
transactions.
During
2009, Series A Warrants to purchase 158,300 shares of common stock were
exercised for 78,565 shares of common stock and Series B Warrants to purchase
123,560 shares of common stock were exercised for 45,764 common stock on a
cashless basis. In connection with these transactions, the Company issued an
aggregate of 124,329 shares of common stock and received no cash proceeds from
such issuances. For cash flow purposes, these transactions were
non-cash transactions.
F-26
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
10 – PREFERRED STOCK AND STOCK WARRANTS (continued)
A summary
of the status of the Company’s stock warrants as of and for the year
ended December 31, 2008 is presented below:
Number
of Shares
|
||||
Balance
– December 31, 2007
|
- | |||
Granted-
Warrants A
|
5,980,955 | |||
Granted-Warrants
B
|
5,924,471 | |||
Exercised
|
- | |||
Cancelled
|
- | |||
Balance
– December 31, 2008
|
11,905,426 | |||
Granted
|
- | |||
Exercised-Warrants
A
|
(158,300 | ) | ||
Exercised-Warrants
B
|
(123,560 | ) | ||
Cancelled
|
- | |||
Balance
– December 31, 2009
|
11,623,566 |
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, "Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity's Own
Stock"). As a result of adopting ASC 815, warrants to purchase 11,905,426
of the Company's common stock previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment as there
was a down-round protection (full-ratchet down round
protection). As a result, the warrants are not considered
indexed to the Company’s own stock, and as such, all future changes in the fair
value of these warrants will be recognized currently in earnings until such time
as the warrants are exercised or expire.
As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in March 2008. On January 1,
2009, the Company recorded as a cumulative effect adjustment of decreasing
additional paid-in capital of $6,020,000 and beginning retained earnings of
$2,792,017 and $8,812,017 to warrant liabilities to recognize the fair value of
such warrants. The fair value of the warrants was $44,304,034 on December 31,
2009. The Company recognized a $35,492,017 loss from the change in fair value of
warrants for the year ended December 31, 2009.
The fair
value was calculated using the Black-Scholes option pricing model. The
assumptions that were used to calculate fair value as of December 31, 2009 and
December 31, 2008 were as follows:
Investor Warrants:
|
12/31/2009
|
12/31/2008
|
||||||
Expected
volatility
|
54
|
%
|
51
|
%
|
||||
Risk
free rate
|
1.82
|
%
|
1.34
|
%
|
||||
Expected
terms
|
3.24
|
4.24
|
||||||
Expected
dividend yield
|
-
|
-
|
Expected
volatility is based on average peer group volatility with comparable size and
operations. The Company did not have enough historical share trade
period and was thinly traded. The Company believes this method
produces an estimate that is representative of the Company’s expectations of
future volatility over the expected term of these warrants. The Company has no
reason to believe future volatility over the expected remaining life of
these warrants is likely to differ materially from historical volatility. The
expected life is based on the remaining term of the warrants. The risk-free
interest rate is based on U.S. Treasury securities according to the remaining
term of the warrants.
NOTE
11 – SHARED BASED COMPENSATION
On
September 14, 2009, the Company entered into stock option agreements with its
three independent directors, Gary Crook, Chaoyang Li and Zhiguo Jin, granting
each director options to purchase 20,000 shares of the Company’s common stock at
an exercise price of $8.00 per share. The options vest in
approximately equal amounts on the three subsequent anniversary dates of the
grant and expire on the fifth anniversary of the date of agreement of or the
date the option is fully exercised. On January30 ,2010, the Company entered into
amendment agreements with its three directors to correct the exercise price to
$7.50, which was the fair market value on the date of the grant
The
Company adopted the fair value recognition which requires the measurement and
recognition of compensation expense for all stock-based payment awards made to
the Company’s employees and directors, including stock options and employee
stock purchases. Stock-based compensation expense for stock options
was based on the grant-date fair value. During the process of
estimating the fair value of the stock options granted and recognizing
share-based compensation, the following assumptions were adopted.
The fair
value for these awards was estimated using the Black-Scholes option pricing
model with the following weighted average assumptions, assuming no expected
dividends:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Expected
life (years)
|
3.5 | - | ||||||
Expected
volatility
|
41.2 | % | - | |||||
Risk-free
interest rate
|
1.69 | % | - | |||||
Dividend
yield
|
- | - |
F-27
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
The
expected volatilities are based on the historical volatility of the Company’s
common stock. The observation is made on a weekly
basis. The observation period covered is consistent with the expected
life of the options. The expected life of stock options is based on
the minimum vesting period required. The risk-free rate is consistent
with the expected terms of the stock options and is based on the United States
Treasury yield curve in effect at the time of grant.
At
December 31, 2009, the Company had stock-based compensation expenses in the
aggregate amount of $.14,252. A summary of stock option activities during the
two-year period ended December 31, 2009 is as follows:
Number
of option
|
Weighted
Average
Exercise
Price
Per
Share
|
Remaining
Contractual life(months)
|
Aggregate
intrinsic
|
|||||||||||||
Balance
– December 31, 2007
|
- | $ | - | - | $ | - | ||||||||||
Granted
|
- | - | - | |||||||||||||
Granted
|
- | - | - | - | ||||||||||||
Exercised
|
- | - | - | |||||||||||||
Cancelled
|
- | - | - | |||||||||||||
Balance
– December 31, 2008
|
- | - | - | - | ||||||||||||
Granted
|
60,000 | 7.5 | 4.65 | - | ||||||||||||
Exercised
|
- | - | - | |||||||||||||
Exercised
|
- | - | - | |||||||||||||
Cancelled
|
- | - | - | |||||||||||||
Balance
– December 31, 2009
|
60,000 | $ | - | 4.65 | $ | - |
The
weighted-average grant-date fair value of stock options granted during the years
2009 and 2008 was$144,498 and nil respectively. The total intrinsic value of
options exercised during the years ended December 31, 2009 and2008 was
approximately nil, respectively.
F-28
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
12 – INCOME TAXES
The
income tax provision consisted of the following:
Years
Ended December 31,
|
2009
|
2008
|
2007
|
|||||||||
Current:
|
||||||||||||
Foreign
|
$ | 4,224,737 | $ | 3,556,474 | $ | 2,997,615 | ||||||
Federal
|
- | - | - | |||||||||
State
|
- | - | - | |||||||||
Deferred
|
||||||||||||
Foreign
|
(416,943 | ) | - | - | ||||||||
Federal
|
- | - | - | |||||||||
State
|
- | - | - | |||||||||
Provision
for income taxes
|
$ | 3,807,794 | $ | 3,556,474 | $ | 2,997,615 |
Deferred
tax assets and liabilities reflect the net tax effects of temporary differences
between carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
that give rise to deferred tax assets and liabilities as of December 31,
2009 were as follows:
December
31,
|
2009
|
2008
|
||||||
Current:
|
||||||||
Accrued
liabilities
|
$ | 239,229 | $ | - | ||||
Non-current:
|
- | - | ||||||
Depreciation
on property, plant and equipment
|
50,299 | - | ||||||
Net
operating loss carry-forward
|
154,476 | |||||||
Total
deferred income taxes
|
444,004 | |||||||
Less:
valuation allowance
|
(27,061 | ) | - | |||||
Net
deferred income taxes
|
$ | 416,943 | $ | - |
As of
December 31, 2009, two new open stores, one department store and Speedy
Brilliant (Daqing) have accumulated operating losses totally of $617,906 for
Chinese income tax purposes, which can be carried forward for 5
years. Management estimates that it is more likely than not that the
potential economic benefits of the net operating loss of Speedy Brilliant
(Daqing) will not be realized in the near future. As a result, the full
amount of the valuation allowance was provided against the potential tax
benefits.
F-29
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
The
difference between the effective income tax rate and the expected federal
statutory rate was as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Statutory
rate
|
34.0 | % | 34.0 | % | ||||
Income
tax rate reduction
|
(9.0 | )% | (9.0 | )% | ||||
Permanent
differences
|
0.6 | % | - | |||||
Valuation
allowance
|
0.2 | % | - | |||||
Warrant Liability | (44.3 | )% | - | |||||
Other
|
0.2 | % | 3.3 | % | ||||
Effective
income tax rate
|
(18.3) | % | 28.3 | % |
The
permanent differences were related to the non-deductible expenses under China
taxation law.
NOTE
13 – SEGMENT INFORMATION
The Group
is principally engaged in the operation of retail chain store in the PRC. Nearly
all identifiable assets of the Group are located in the PRC. All revenues are
derived from customers in the PRC. Accordingly, no analysis of the Group’s sales
and assets by geographical market is presented.
For the
years ended December 31, 2009 and 2008, the Group’s net revenues from external
customers for products and services are as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Sale
of general merchandise
|
$ | 244,566,173 | $ | 157,841,011 | ||||
Department
store income
|
2,348,033 | 1,857,340 | ||||||
Other
income
|
680,066 | 431,249 | ||||||
Total
|
$ | 247,594,272 | $ | 160,129,600 |
For the
years ended December 31, 2009 and 2008, the Group’s net revenues from external
customers for sale of general merchandise by categories of product are as
follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Grocery
|
$ | 82,219,402 | $ | 51,013,639 | ||||
Fresh
food
|
116,136,695 | 79,739,451 | ||||||
Non-food
|
46,210,076 | 27,087,921 | ||||||
Total
|
$ | 244,566,173 | $ | 157,841,011 |
F-30
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
14 –COMPREHENSIVE INCOME
Total
comprehensive income includes, in addition to net income, changes in equity that
are excluded from the consolidated statements of income and are recorded
directly into a separate section of shareholders’ equity on the consolidated
balance sheets. Comprehensive income and its components consist of
the following:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Net
income
|
$ | (24,643,438 | ) | $ | 8,997,068 | |||
Foreign
currency translation adjustment
|
495,097 | 2,434,364 | ||||||
Comprehensive
income
|
$ | (24,148,341 | ) | $ | 11,431,432 |
NOTE
15 - COMMITMENTS AND CONTINGENCIES
Operating
Leases
Certain
of our real properties and equipment are operated under lease agreements. Rental
expense under operating leases was as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Rent
expense
|
$ | 2,150,986 | $ | 1,312,720 | ||||
Less:Sublease
income
|
737,370 | 800,344 | ||||||
Total
rent expense, net
|
$ | 1,413,616 | $ | 512,376 |
Annual
minimum payments under operating leases are as follows:
Years
Ended December 31,
|
Minimum
Lease
Payment
|
Sublease
Income
|
Net
Minimum
Lease
Payment
|
|||||||||
2010
|
$ | 2,532,719 | $ | 519,494 | $ | 2,013,225 | ||||||
2011
|
2,169,206 | 76,412 | 2,092,795 | |||||||||
2012
|
2,092,083 | 14,073 | 2,078,008 | |||||||||
2013
|
1,991,294 | - | 1,991,294 | |||||||||
2014
|
1,436,842 | - | 1,436,842 | |||||||||
Thereafter
|
11,696,317 | - | 11,696,317 | |||||||||
Total
|
$ | 21,918,461 | $ | 609,979 | $ | 21,308,481 |
F-31
QKL
STORES INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
As of
December 31, 2009 and 2008, buildings with net book value of nil and $4,538,407
respectively of the Company were pledged as collateral under loan
arrangements.
As of
December 31, 2009 and 2008, land use rights with net book value of nil and
$621,191 respectively of the Company were pledged as collateral for the above
loan arrangements. These loans were primarily obtained for general working
capital.
Litigation
The
Company is not involved in legal proceedings and claims.
NOTE
16 – SUBSEQUENT EVENTS
In May
2009, the FASB issued new guidance on subsequent events. The standard provides
guidance on management’s assessment of subsequent events and incorporates this
guidance into accounting literature. The standard is effective prospectively for
interim and annual periods ending after June 15, 2009. The implementation
of this standard did not have a material impact on the Company’s
consolidated financial position and results of operations.
The
Company amended Series A and Series B warrant agreements deleting or amending
the down-round protection (full-ratchet down round protection) provision on
March 24, 2010. As a result of this amendment, the Company will
no longer be required to treat Series A and Series B warrants as a liability and
will be reclassified to equity subsequently.
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, "Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity's Own
Stock"). As of and for the quarter ended March 31, 2009, June 30,
2009, and September 30, 2009, the Company erroneously did not account its Series
A and Series B warrants of 11,905,426 as a derivative accounting as there was a
down-round protection (full-ratchet down round protection) and the
warrants are not considered indexed to the Company’s own
stock. The Company expects to restate those quarters as soon as it is
practical to do so.
F-32
QKL
STORES INC. AND SUBSIDIARIES
SCHEDULE
II – VALUATION AND QUALIFYING ACCOUNTS
Balance
at
|
Charged
to
|
Balance
at
|
||||||||||||||
Beginning
of
|
Costs
and
|
End
of
|
||||||||||||||
Period
|
Expenses
|
Deductions
|
Period
|
|||||||||||||
December
31, 2009
|
||||||||||||||||
Allowance
for doubtful receivables
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-.
|
||||||||
Allowance
for sales returns
|
--
|
1,142,016
|
1,132,018
|
9,998
|
||||||||||||
Inventory
reserves
|
82,228
|
230,685
|
250,358
|
62,555
|
||||||||||||
December 31,
2008
|
||||||||||||||||
Allowance
for doubtful receivables
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
||||||||
Allowance
for sales returns
|
-
|
775,265-
|
775,265
|
-
|
||||||||||||
Inventory
reserves
|
100,095
|
173,794
|
191,661
|
82,228
|
II
SIGNATURES
In
accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this amended report to be signed on its behalf by the
undersigned thereunto duly authorized on April 1, 2010.
QKL
STORES INC.
|
|
/s/ Zhuangyi Wang
|
|
By:
/s/ Zhuangyi Wang
|
|
Chief
Executive Officer and Director
(principal
executive officer)
|
In
accordance with the requirements of the Securities Exchange Act of 1934, this
Amended Report was signed by the following persons in the capacities and on the
dates indicated.
Name and Title
|
Date
|
|
/s/ Zhuangyi Wang
|
April
1, 2010
|
|
Zhuangyi
Wang
|
||
Chief
Executive Officer and Director
|
||
(principal
executive officer)
|
||
/s/
Crystal Chen
|
April
1, 2010
|
|
Crystal
Chen
|
||
Chief
Financial Officer
|
||
(principal
financial officer and accounting officer)
|
||
/s/ Alan
Stewart
|
April
1, 2010
|
|
Alan
Stewart
|
||
Director
|
||
/s/ Gary
Crook
|
April
1, 2010
|
|
Gary
Crook
|
||
Director
|
||
/s/ Zhiguo
Jin
|
April
1, 2010
|
|
Zhiguo
Jin
|
||
Director
|
||
/s/ Chaoying
Li
|
April
1, 2010
|
|
Chaoying
Li
|
|
|
Director
|
54
EXHIBIT
INDEX
3.1
|
Certificate
of Incorporation (2)
|
|
3.2
|
Bylaws
(2)
|
|
3.3
|
Certificate
of Amendment of Certificate of Incorporation (7)
|
|
4.1
|
Specimen
of Common Stock certificate (1)
|
|
4.2
|
Certificate
of Designations authorizing the Series A Preferred Stock
(1)
|
|
4.3
|
Form
of Series A Warrant (1)
|
|
4.4
|
Form
of Series B Warrant (1)
|
|
4.5
|
Warrant
Amendment to the Series A Warrant to Purchase Shares of Common Stock of
the Company, dated as of March 24, 2009, by and among the Company and
Vision Opportunity China LP
|
|
4.6
|
Warrant
Amendment to the Series B Warrant to Purchase Shares of Common Stock of
the Company, dated as of March 24, 2009, by and among the Company and
Vision Opportunity China LP
|
|
10.1
|
Series
A Convertible Preferred Stock Purchase Agreement, dated as of March 28,
2008 between the Company and the Purchasers (1)
|
|
10.2
|
Registration
Rights Agreement dated March 28, 2007, by and among the Company and the
Purchasers (1)
|
|
10.3
|
Lock-Up
Agreement, dated as of March 28, 2007, by and among the Company and
Winning State (BVI) (7)
|
|
10.4
|
Securities
Escrow Agreement, dated March 28, 2008, by and between the Company, Vision
Opportunity China LP as representative of the Purchasers, Winning State
(BVI) and Loeb & Loeb LLP, as escrow agent (1)
|
|
10.5
|
Investor
and Public Relations Escrow Agreement dated March 28, 2008 between the
Company and Vision Opportunity China LP as representative of the
Purchasers and Loeb & Loeb, as escrow agent (1)
|
|
10.6
|
Share
Exchange Agreement, dated as of March 28, 2008 between the Company, the
controlling stockholder of the Company, Winning State (BVI), Fang Chen,
Yang Miao and Ying Zhang (1)
|
|
10.7
|
Consigned
Management Agreement, dated as of March 28, 2008 (1)
|
|
10.8
|
Technology
Service Agreement dated as of March 28, 2008 (1)
|
|
10.9
|
Loan
Agreement, dated as of March 28, 2008 (1)
|
|
10.10
|
Exclusive
Purchase Option Agreement, dated as of March 28, 2008
(1)
|
|
10.11
|
The
Equity Pledge Agreement, dated as of March 28, 2008 (1)
|
|
10.12
|
Engagement
Letter Agreement, dated March 9, 2007, by and between QKL and Kuhns
Brothers, Inc. (2)
|
|
10.13
|
Settlement
Agreement, dated January 22, 2008, by and between QKL and Kuhns Brothers,
Inc. (2)
|
|
10.14
|
Financial
Consulting Agreement, dated March 13, 2007 between QKL and Mass Harmony
Asset Management Limited (3)
|
|
10.15
|
Amendment
dated May 8, 2008 to Registration Rights Agreement dated March 28, 2007,
by and among the Company and the Purchasers (3)
|
|
10.16
|
Form
of employment agreement (7)
|
|
10.17
|
Waiver
and Release dated as of March 9, 2009. (5)
|
|
10.18
|
Agreement
dated October 31, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Fuyu Count Xinshuguang
Real Estate Development Co., Ltd (6)
|
|
10.19
|
Agreement
dated October 31, 2008 between Daqing Qingkelong Chain Commerce &
Trade Co., Ltd. and Hulunbeier Huahui Co., Ltd
(6)
|
|
10.20
|
Agreement
dated August 31, 2008 between Daqing Qingkelong Chain Commerce & Trade
Co., Ltd. and Heilongjiang Longmei Commerce Co., Ltd
(6)
|
|
10.21
|
Agreement
dated September 30, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Nehe City
Wanlong Co., Ltd. (6)
|
|
10.22
|
Agreement
dated September 30, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Daqing Xinguangtiandi
Shopping Center Co., Ltd. Incorporated by reference to our Registration
Statement of Form S-1/A (Reg. No. 333-150800) filed with the SEC on March
11, 2009. (6)
|
|
10.23
|
Waiver
dated October 15, 2009 to the Registration Rights Agreement dated March
28, 2008, by and between the Company and Vision Opportunity China LP, as
representative of the Purchasers (7)
|
|
10.24
|
Waiver
dated October 15, 2009 to the Securities Purchase Agreement dated March
28, 2008, by and between the Company and Vision Opportunity China LP, as
representative of the Preferred Shareholders (7)
|
|
10.25
|
Amendment
to Securities Escrow Agreement dated October 15, 2009 to the Securities
Escrow Agreement dated March 28, 2008, by and among the Company Vision
Opportunity China LP, as representative of the Purchasers, Winning State
Investment Limited, and Loeb & Loeb LLP, as escrow agent
(7)
|
|
10.26
|
Lock-up
Letter dated October 15, 2009, by and among Roth Capital Partners, LLC,
the Company, our directors, executive officers and Winning State
International Limited (7)
|
|
10.27
|
2009
Omnibus Securities and Incentive Plan (7)
|
|
10.28
|
Form
of Independent Director Agreement
(7)
|
55
10.29
|
Form
of Waiver to Certificate of Designations, Preferences and Rights of Series
A Convertible Preferred Stock, dated as of March 25, 2010, by and among
the Company and the holders of Series A Convertible Preferred
Stock
|
|
10.30
|
Property
Buying/Selling Contract, dated December 30, 2009 (8)
|
|
10.31
|
Amendment No. 2 to Securities Escrow Agreement dated April 1, 2010 | |
16.1
|
Letter
from the Company to Comiskey and Company, P.C. (2)
|
|
16.2
|
Letter
from Comiskey and Company, P.C. to the SEC (2)
|
|
16.3
|
Letter
from Albert Wong & Co. to the SEC (7)
|
|
21.1
|
List
of Subsidiaries (3)
|
|
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
31.2
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
32
|
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
(1)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on April
3, 2008.
|
|
(2)
|
Incorporated
by reference to our current report on Form 8-K/A filed with the SEC on
April 14, 2008.
|
|
(3)
|
Incorporated
by reference to our Registration Statement of Form S-1 (Reg. No.
333-150800) filed with the SEC on May 9,
2008.
|
|
(4)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-150800) filed with the SEC on August 7,
2008.
|
|
(5)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-150800) filed with the SEC on March 11,
2009.
|
|
(6)
|
Incorporated
by reference to our Form 10-K filed with the SEC on April 14,
2009.
|
|
(7)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-162150) filed with the SEC on October 19,
2009.
|
|
(8)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on
January 25, 2010.
|
56